The South African Reserve Bank has announced that it will maintain the Repo rate at 8.25%, the same rate since May 2023, meaning the prime lending rate remains at 11.75%. While this stability prevents an increase in borrowing and debt costs, it maintains a high rate. Despite a slight easing of the inflation rate and an expectation for further relief in 2024, most economists do not foresee a drop in the repo rate before mid-year, or possibly later.
According to Miguel da Silva, Managing Executive of Retail Capital, a division of TymeBank, continuous high interest rates put pressure on the vital SME sector in South Africa: “We know that a key reason for high interest rates is to control inflation. We urge the South African Government to examine the factors that cause our high inflation rate and implement measures to alleviate the problem where possible so we can see a future reduction in interest rates. South Africa’s SMEs are vital to our economy. These businesses have shown incredible resilience in navigating the challenges posed over the past few years, but they need relief. When our SMEs are doing well, our economy does well.”
The SME sector serves as a primary job creator and a major economic driver but sustained high interest rates have placed it in a challenging position. To counter these effects, it is essential to assess the impact of high interest rates on small businesses and explore potential solutions.
Here we explore the importance and impacts of the interest rate for business:
The Cost of Debt
The sustained high interest rates mean the cost of doing business remains high. Servicing various types of debt, including property bonds, bank loans, credit cards, and other credit instruments, remains expensive. The cumulative effect of prolonged high interest rates puts significant pressure on SMEs’ bottom lines, leading many businesses to explore debt restructuring and alternative financing options.
Leverage, a key aspect of operational success, involves obtaining finance at a lower rate to fund operational profit at a higher rate. The higher interest rates have disrupted the benefit of leveraging, but with a downward trend in inflation globally – and particularly in larger, developed economies like the US and Europe – the interest rate in South Africa is expected to eventually follow which would mean leveraging as a business tool could be back on the table.
High interest rates affect consumer spending, because cost of personal debt increases, and all businesses providing goods and services have their bottom line impacted. The interconnected nature of the economy means that when consumers face financial constraints, businesses across various sectors feel the impact. In a challenging economic environment, businesses may need to offer lower prices to retain customers, which is difficult to do when business costs are going up in real terms.
This can lead to unenviable practices like shrinkflation, where the weight, units, or volume of a product decreases while the price remains the same.
Sustained high interest rates limit businesses’ ability to invest in equipment, improved processes, or new staff. Businesses are forced to extend the lifespan of existing equipment and find innovative ways to reduce maintenance costs. Delays in non-essential work may become necessary until economic conditions improve.
Cash flow, essential for any business, becomes restricted with higher interest rates. Operational expenses, such as payroll, inventory, maintenance, and consumables, relying on positive cash flow, face increased pressure, affecting a business’s ability to sustain itself and remain profitable.
“It is always easier to say then do, but my advice to SMEs is to hold on at all costs,” said Da Silva. “Expectations are that interest rates will come down.
“Be upfront with suppliers and work out revised payment schedules. The suppliers you work with are usually in the same boat, and they know that interest rates must come down, and it is in their interest to help keep customers going until things improve.”
As businesses navigate challenges posed by sustained high interest rates, proactive measures, including debt restructuring, leveraging opportunities, adapting to consumer spending patterns, managing investments, and optimizing cash flow, are crucial for SMEs to weather the economic storm.