How Are CPF Interest Rates Calculated? Will They Increase In A High Interest Rate Environment?

Much has been said about the high interest rate and inflationary environment that we are living in today. This has put household budgets under great stress. To address the higher cost of living, opposition politician Jamus Lim proposed in a recent Parliament session to raise CPF interest rates temporarily. But can CPF Board really increase their interest rates according to its whim and fancy?   Coupled with higher borrowing rates in Singapore, this has cast greater spotlight on how CPF compute their interest rates. Therefore, I will explain in this article how CPF interest rates are calculated and how likely they will increase given the current high interest rate environment.

How is CPF OA interest rate calculated?

According to CPF’s website, “savings in the Ordinary Account (‘OA’) earn the 3-month average of major local banks’ interest rates, subject to the legislated minimum interest of 2.5% p.a.” The rate is also reviewed quarterly which means they are not stagnant and will be adjusted to the latest market conditions. For the period of 1 July 2022 to 30 September 2022, the CPF OA interest rate is 2.5% which is the legislated floor rate. Let us study the formula of how the 3-month average of major local banks’ interest rates are computed.

According to Diagram 1, the average banks’ interest rate from February 2022 to April 2022 was 0.09%. Since this was lower than the legislated floor rate, CPF members continue to enjoy 2.5% for their funds in CPF OA. Like many of you might be, I was surprised to learn that the derived average banks’ interest rate was so low at 0.09%. Aren’t we supposedly receiving approx. 2-3% interest rates on DBS Multiplier, UOB One and OCBC 360 savings accounts as advertised? The stark discrepancy prompted me to study the formula further.

Firstly, we need to understand that the average banks’ interest rate is a blended rate consisting of the following:

• 20% savings rate, and
• 80% the average 12-month deposit rate

If you scrutinise Diagram 1 carefully, the banks’ average savings rate is 0.05% – a far cry from the 2% to 3% aforementioned! That is because the interest rates are referenced from AUTO-SAVE, EASI-SAVE and UNIPLUS Accounts. Generally, these are basic savings account that provides basic banking services at minimal costs.

With regards to the 12-month deposit rate, the interest rates offered by the 3 local banks range from 0.05% to 0.15%. This appears to be very low as we are seeing banks marketing significantly higher interest rates these days.

For instance, UOB is already offering 1.4% p.a. for a 10-month Singapore Dollar Fixed Deposit during its July promotion.

As shown in Diagram 3, OCBC is offering 1.5% for Singapore Dollar time deposit with 12-month tenure for a limited time only.

The interest rates shown in Diagrams 2 and 3 contrast greatly with the rates shown in Diagram 1. That is because CPF Board does not recognise these promotional rates that are offered for a limited time only. Instead, only the published fixed deposit rates offered under regular/base scenarios are recognised. They are more commonly known as board rates which is the rate that will be applied to your fixed deposits under normal circumstances/non-promotion period.

OCBC’s board rate is shown in Diagram 4 and you will notice that what that I have boxed matches the corresponding figure (0.1%) in Diagram 1.

Having explained how the 12-month deposit rate and savings rate are referenced, we should now realise why the average banks’ interest rate from Feb to Apr 2022 was so low at 0.09%.

Will CPF OA Interest Rate Increase At The Next Few Reviews?  

For the 20% component, I think it is almost a certainty that it will stay at 0.05%. For the longest time as far as I can remember, it has stayed at 0.05%. For the 80% component, I am unsure if the banks will change their base rates for fixed deposits. To attract new deposits and fresh funds, the local banks will be more inclined to do it by running limited-time promotions. I think there is also nothing stopping them from running and refreshing these promotions in perpetuity?

Therefore, my guess is that it is very unlikely that the CPF OA interest rate will be increased at the next few reviews based on the prescribed formula.

How Is CPF SA/MA determined?

According to CPF’s website, “savings in the Special (‘SA’) and MediSave Accounts (‘MA’) earn the 12-month average yield of 10-year Singapore Government Securities (10YSGS) plus 1%, subject to the current floor interest rate of 4% p.a.” Again, this is reviewed quarterly.

Based on this formula, the average yield of 10YSGS from May 2021 to April 2022 was 1.72% as shown in Diagram 5. After adding the 1% margin, this worked out to 2.72%. As this was lower than the floor interest rate of 4% p.a., CPF members continue to enjoy 4% p.a. interest rate on their funds in the SA and MA from the period of 1 Jul – 30 Sep 2022.

Will CPF SMA Interest Rates Increase At The Next Few Reviews?  

To answer this question, I checked the historical 12-month average yield of 10YSGS from the MAS website. At the next review, the 12-month average yield should be taken from the period of Aug 2021 to July 2022.

As shown in Diagram 6, the 12-month average yield of 10YSGS would be approx. 2.04%. After adding in 1%, the computed SMA rate at the next review should be somewhere around 3%. Since this is still below the interest rate floor, the CPF SMA interest rate is unlikely to change at the next review.

How about at subsequent reviews? For the final SMA interest rate to increase above the floor rate of 4%, this implies that the 12-month average yield of the 10YSGS must be consistently above 3%. As shown in Diagram 6, this happened occasionally during June when market was spooked by a 75 basis point hike. However, market got to stay this way for at least the next 10 months in order for the 12-month average yield to be above 3%. This is plausible and not as impossible as the CPF OA rate.

Impact of CPF increasing interest rates

Under the hypothetical scenario that CPF OA interest rate rises above 2.5%, HDB home owners who take up a HDB loan will have to pay a higher interest rate. In a recent article, I suggested that HDB loan is now a better option than bank loan for BTO and resale HDB buyers in 2022. Having studied how CPF OA rates are calculated, my outlook on this issue remains unchanged.

A higher CPF OA interest rate would also mean that those who use CPF OA funds to invest have a higher hurdle to clear. This changes the opportunity cost of an investor’s capital since the guaranteed returns for doing nothing are now higher.

On the other hand, a higher CPF SA and MA interest rate would be good news for retirees or those accruing and building up their retirement funds!

Conclusion

I can understand why CPF members currently harbour expectations that CPF interest rates might be increased at the next review. After all, Singapore Savings Bonds are at historical high. However, after spending time to analyse the formulae, it is very unlikely that CPF interest rates, especially the OA interest rate, will be increased at the next few reviews. Of course if it decides to take up Jamus Lim’ s suggestion to raise CPF interest rates temporarily then it is a different story altogether.

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