SINGAPORE, July 22 (Reuters) - Singapore's plan to launch a savings bond to encourage long-term retail savings is unsettling domestic banks and economists who fear this bond will push interest rates up and suck cash out from an already anaemic economy.
The new bond, which will begin selling in October, will have a term of 10 years. It will offer the same yields as government bonds or ten times the returns on bank deposits, and can be redeemed without penalty at any point.
Such a juicy proposition could cause a flight of cash from bank deposits into these bonds and force interest rates higher as banks compete to attract savers.
The government says it will issue a maximum of S$4 billion worth of bonds this year, which is still more than a fifth of deposit growth in 2014.
The timing of these bonds, which are aimed at meeting a long-felt need for long-term investment options in the low-yielding economy, couldn't be worse.
The economy contracted sharply in the second quarter as manufacturing slumped and is at risk of tipping into technical recession. Price pressures are subdued and expectations are building for the central bank to ease policy once again at a twice-yearly review in October.
"Launching a retail savings bond now is almost like reverse QE," said Chua Hak Bin, an economist with BofA Merrill Lynch in Singapore, referring to the unorthodox quantitative easing (QE) policies the United States and other major economies have pursued in the years since the 2007 financial crisis.
Chua points to the already slowing deposit growth in the Singapore banking system, with just S$3.8 billion ($2.8 billion)of deposits being added in the first five months of 2015, just 20 percent of the total growth last year.
He suspects the government would invest the savings bond flows overseas. That would further pressure loan growth, by tightening available cash and triggering a rise in deposit rates, he said.
"So the timing is not ideal. The economy has stagnated in the first half and this will worsen the situation," Chua said.
Citibank analysts expect that of a total S$559 billion of deposits in the banking system, 36 percent are savings deposits held by households. If on average the MAS issued about S$6 billion worth of bonds each year, S$30 billion would flow from the deposit base into bonds over five years, they estimate.
Singapore's central bank, the Monetary Authority of Singapore (MAS), has set a cap of S$100,000 on individual investments in the bond.
MAS Managing Director Ravi Menon played down fears the bond will cannibalise bank deposits.
"The savings bonds issuance numbers pale in significance compared to the total size of the banking deposits," he said at a news conference this week.
Yet there is little doubt the bonds will draw savers from banks. Government bonds yield about 0.95 percent for one-year and 2.6 percent for 10-years. Bank deposits fetch around 0.25 percent for a year and just double that for 24 months.
"The Singapore Savings Bond is bending the risk-reward paradigm in investors' favor," said Zal Devitre, head of investments at Citibank in Singapore.
Devitre believes retail investors and consumers will be keen to buy the bonds, and yet thinks it is premature to be projecting the impact that will have on rates and banking system liquidity.
Local banks such as DBS, Oversea-Chinese Banking Corporation and UOB are expected to be impacted if there is a heavy migration of deposits.
But analysts also expect there will be more pressure on global banks such as Citibank, Standard Chartered , HSBC and Malayan Banking Bhd, which have been deemed systemically important by Singapore and therefore need to maintain higher capital than stipulated under the Basel 3 guidelines. (Additional reporting by Saeed Azhar in Singapore; Editing by Simon Cameron-Moore)