Various factors contribute to the success or challenges faced by businesses in the dynamic landscape of South African SMEs. One crucial element that significantly influences business operations is the interest rate. In this blog, we’ll further explore the concept of interest rates and discuss their impact on businesses.
The current economic climate
In the latest 2024 National Budget Speech, we were faced with S.A’s weak economic performance, which is set to lead to a sharp deterioration in tax revenue collection for 2023/24. With this in mind, Government has proposed certain tax measures to alleviate immediate fiscal pressure and to support debt stabilisation. Finance Minister Enoch Godongwana reported at R1.73 trillion, tax revenue for 2023/24 is R56.1 billion lower than estimated in the 2023 Budget. The shortfall is largely due to the decline in corporate profits and revenue from mining taxes. Over the medium term, revenue projections are R45.6 billion higher than the 2023 Medium Term Budget Policy Statement (MTBPS) estimates, which increased personal income tax and additional medium term revenue proposals. Consumer Price Inflation (CPI) has also ticked up at the start of 2024, but softening food prices provides some relief for cash-strapped consumers. The categories with the largest annual price increases were restaurants and hotels at 8.0%, food & non-alcoholic beverages (NAB) at 7.2%, and health at 6.5%. At the time of publishing this article, South Africa’s repo rate was 8.25%, and the interest rate was 11.75%.
Understanding the Interest Rate
Let’s begin with some definitions and how they all work together.
The repo rate:
The repo rate, also known as the repurchase rate, is the rate at which a country’s central bank lends money to commercial banks. In South Africa, our repo rate is set by the South African Reserve Bank (SARB). When traditional banks need funds, they can borrow from the central bank. The repo rate is the interest that is charged on these loans.
The interest rate:
The interest rate is the cost of borrowing money or the return on investment for lending money. It represents the percentage of the loan amount that a borrower pays the lender as compensation for using the funds. It is typically expressed as an annual percentage and is applied to various financial products, including loans, credit cards, and savings accounts. It is also important to note that the central bank will use the interest rate to manage inflation. So, when inflation is high or rising, the central bank may choose to increase the interest rate in an effort to reduce the pace of borrowing and spending money in the economy.
Inflation:
Inflation refers to the sustained increase in the general price level of goods and services in a country over a period of time. It means that, on average, prices are rising, and the purchasing power of money is decreasing. Inflation is usually measured as an annual percentage rate, reflecting the percentage change in prices compared to the previous year. Inflation can have various causes, such as increased production costs, a decline in the value of the Rand, unexpected disruptions of supplies and goods, political instability or changes in consumer demand.
How these rates work together:
Let's understand how interest, repo and inflation rates work together to determine loan rates. Traditional banks play a crucial role in the lending process, and when determining the interest rates on loans, they consider the repo rate as a benchmark. The repo rate set by SARB serves as a signal for the overall cost of borrowing in our economy.
SARB regularly reviews and adjusts the repo rate to manage the country's monetary policy and economic conditions. They increase or decrease the repo rate based on factors like inflation, economic growth, employment rates, and currency stability.
So, when the repo rate changes, it affects the cost at which traditional banks can borrow money from the South African Reserve Bank. If the repo rate increases, it becomes more expensive for banks to borrow funds. Conversely, if the repo rate decreases, banks can access funds at a lower cost.
The banks consider their borrowing costs, including the repo rate, along with other factors, like operational expenses and credit risk, to determine the interest rates they offer us as consumers. When the repo rate increases, it puts upward pressure on banks' borrowing costs, which leads them to increase the interest rates on loans. Conversely, if the repo rate decreases, banks may lower their lending rates to make borrowing more affordable.
It's worth noting that other factors like market conditions, the creditworthiness of borrowers, and competition among lenders also influence loan rates. Still, the repo rate serves as an important reference point in the process.
Now, let’s look at some of the ways that the interest rate impacts SMEs
Consumer Spending:
Following the latest budget speech various industries are expected to see above-inflation increases, such as the alcohol industry which is expecting increases of between 6.7% and 7.2%. This means the end-customer will feel it in the following ways: A can of beer increases by 14 cents, a can of a cider and alcoholic fruit beverage may go up by 14 cents and a bottle of wine will now cost an extra 28 cents. Similarly, National Treasury also proposed to increase tobacco excise duties by 4.7% for cigarettes and cigarette tobacco, and by 8.2% for pipe tobacco and cigars. For the consumer this translates to a R9.51 cents increase for cigars, a 97 cents increase to a pack of cigarettes, and an extra 57 cents for a pipe of tobacco. Annual inflation for food and non-alcoholic beverages decreased from 8.5% in December to 7.2% in January, with all sub-categories, except for sugar, sweets & desserts, oils & fats, and cold beverages, seeing a decline.
As interest rates rise, borrowing also becomes costlier, resulting in reduced consumer spending overall. Businesses then experience a decline in sales as customers cut back on discretionary purchases. Here we see how interest rates have a direct impact on consumer behaviour and their purchasing power. When interest rates are low, borrowing becomes more affordable, stimulating consumer spending. SMEs benefit from increased consumer demand, leading to higher sales volumes and revenues.
Cost of Borrowing:
Some businesses use credit to finance inventory, equipment purchases, and expansion plans. Changes in interest rates influence the cost of borrowing capital from banks or other financial institutions. With low interest rates, businesses can obtain loans at more favourable terms, reducing their overall financing costs. Conversely, higher interest rates can increase borrowing costs, potentially squeezing profit margins and limiting business expansion opportunities.
Often, SMEs will look to alternative business funding providers like Merchant Capital, who use a fixed cost of funding instead of an interest rate that fluctuates in accordance with economic factors.
Debt Servicing:
SMEs with existing debt obligations are directly affected by interest rate fluctuations. When interest rates rise, the cost of servicing existing loans increases. This can put a strain on the cash flow of businesses, potentially affecting their ability to meet other financial obligations, such as payroll and supplier payments. In extreme cases, high interest rates may lead to default and insolvency for highly leveraged businesses.
Investment and Expansion:
The interest rate environment influences investment decisions for SMEs. Low interest rates incentivise companies to invest in new stores, renovate existing premises, or upgrade technology and equipment. Lower borrowing costs make expansion plans more financially viable. In contrast, high-interest rates often deter businesses from pursuing growth initiatives, as the cost of capital becomes prohibitive. Business owners may delay or scale back expansion plans, which could impact job creation and overall economic growth.
Exchange Rates and Imports:
A higher interest rate compared to other economies may attract foreign investors seeking better returns. This influx of foreign capital can strengthen the local currency, making imports relatively cheaper for SMEs. Conversely, when interest rates are lower than those in other countries, capital outflows may weaken the currency, making imports more expensive. SMEs relying on imported goods may face higher costs and need to adjust pricing strategies to maintain competitiveness.
The bottom line
The impact of the current interest rate on businesses highlights the importance of adaptability and strategic planning. By staying informed, closely monitoring market trends, and implementing proactive measures, SMEs can navigate the ever-changing interest rate landscape and position themselves to survive and ultimately thrive.
