The Long-Term Effects Of Interest Rate Hikes On Small Business Viability

Sahil owns a small restaurant in Chennai. To expand his business, he took a loan of ₹10 lakh at 9% interest. His monthly EMI was around ₹12,667.

However, after 2 years, the interest rate suddenly increased. Now, the interest rate for his loan is 13%, and his monthly revised EMI is ₹14,810.

That’s an increase of ₹2,143 per month. This extra cost and slow sales forced him to delay vendor payments and reduce staff hours.

You can see many examples like Sahil’s. If you are a small business owner, you might know that most businesses have recently suffered due to continuous rate hikes.

In this blog, we will help you understand the long-term effects of interest rate hikes on small business viability.

Why Do Interest Rates Increase?

Mainly, rates of interest are increased by the central banks to control inflation and manage money flow in the economy. 

If the inflation rate in the economy goes above the desired level, then the interest rate is increased to slow down spending and borrowing.

From the table above, we can see that as soon as inflation goes above 6%, the repo rate increases constantly after 2022.

Higher Loan EMIs And Credit Cost

You might rely on term loans, overdrafts, or working capital loans to fulfil your daily business needs. A rise in interest rates directly impacts loan EMIs, and your business has to face the consequences.

We can see that your loan of ₹5 lakh will become costlier by ₹1,785 per month when the interest rate rises from 9% to 16%.

Impact On Working Capital

As a small business owner, Tanya mostly relies on loans for working capital. If the cost of interest increases then she has to compromise on the quality, reduce inventory, or delay salary payments to manage the loss. 

Such an increment of ₹44,000 in interest over three years can hurt Tanya’s business if her yearly profit is between ₹3 and 4 lakh.

Reduced Profit Margins

Rising interest rates can become a nightmare for your business profits. Also, each time interest rates increase, due to market competition, you cannot increase product prices to cover the increase.

Leo took a loan of ₹5 lakh for his business in 2021. Let’s look at how increasing interest rates are affecting his business profits:

Delayed Expansion And Hiring Plans

Most small businesses depend on loans for the expansion of their business. If borrowing becomes expensive, you might have to postpone expanding your business or hire staff.

Such extra costs might demotivate you from making an investment in the growth of the business.

Consumer Spending Slows Down

When people see that the rates are rising for cars, homes, and personal loans, they reduce their household spending. Such decisions directly impact a business selling non-essential products.

Such a high interest rate will decrease demand, particularly in the electronics, apparel, and furniture sectors.

How Can You Cope With Rising Interest Rates?

It is not in your hands to control the increasing rates,, but you can manage risks for your small business. 

1. Avoid non-essential expenses.
2. Negotiate better terms with lenders.
3. Try to do part of the prepayment of loans.
4. Switch to fixed-interest loans.
5. Tighten inventory and credit controls.
6. Build emergency cash reserves

Final Thoughts

The government might increase the rate of interest temporarily to control inflation, but this would have a long-term impact on small businesses.

You need to be financially prepared in advance to tackle such uncertainties. You must manage costs, borrow wisely, and plan for the worst-case scenario to be stable and viable during such times.

From an increase in EMIs to a reduction in profits and a postponement of business growth, such pressures can push even stable businesses into trouble.

If you want your small business to survive in the market in the long run, you must develop the ability to adapt to rapid changes.

FAQs

1. Do rising rates lead to payment delays?

Yes, clients take longer to pay due to tight cash flow.

2. Can small business sales fall when rates go up?

Yes, customers may cut spending, reducing overall sales.

3. How long do high-interest phases usually last?

They may last anywhere from two to five years.

4. Do rate hikes slow down business expansion?

Yes, firms avoid new loans due to high costs.

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LoansJagat Team

We are a team of writers, editors, and proofreaders with 15+ years of experience in the finance field. We are your personal finance gurus! But, we will explain everything in simplified language. Our aim is to make personal and business finance easier for you. While we help you upgrade your financial knowledge, why don't you read some of our blogs?