Interest rate rises: why every business should be interested

Think an interest rise would be no big deal for your company? Maybe, but then again, maybe you’re not seeing the full picture. We give three ways to gain a new (and interesting) perspective.

Something in the latest edition of our CFO Sentiment survey piqued my interest. 33% of Australian CFOs told us that the scenario they would find most useful if undertaking strategic planning would be the consequences of interest rates returning to historic norms.

I was curious for a few reasons.

We know that at some stage, interest rates will rise again. However, interest rates are so low at the moment that it will take a while before the rates reach their historical norm. And most Australian listed companies are not highly geared or exposed.

Take these together, and an interest rates increase, at least in the medium term, looks like it would have minimal impact on Australian businesses.

Therefore why would our leading CFOs be concerned about it?

It’s the realisation that it is not only the direct impact but also the indirect impact that matters. The direct impacts of a rates rise on your business are increased repayments, decreased profits, balance sheet uncertainty and hesitancy around investing in new growth initiatives. The indirect impacts are those it can have on your customers, suppliers and ecosystem partners – all things are not equal for all companies and it’s certainly not a one size fits all approach.

The underlying messaging in our Building the Lucky County #6 publication (BTLC#6) – What’s over the Horizon: Recognising opportunity in uncertainty, is that we need to test our assumptions, and look in different ways at how we forecast and plan for what could happen.

The full picture

So what is the likely impact on your customers, suppliers and third parties?

The impacts of an interest rates rise on customers could be much more significant than they would be for a business. Interest rates can impact consumer sentiment and will directly impact property prices, discretionary expenditure, household spending behaviours, retail and construction.  All of which could cause exposure for Australian businesses through their expanded ecosystem. According to Deloitte Access Economics’ calculations, each percentage point rise in mortgage rates is estimated to cause a 7% fall in average dwelling prices – all other factors held constant.

Given the low levels of debt and high cash reserves in much of corporate Australia, the cost of debt may not be high on the list of issues to be concerned about. But what about the toll that this increase could take on your buyers and suppliers – with a flow on effect to your company’s bottom line?

A healthy economy means a healthy business, but when the conditions start to become variable such as interest rates rising, the landscape of corporate profitability can quickly change.

What you should do?

We’re not suggesting businesses in Australia are complacent.

I know from my frequent conversations with CEOs and Executives, they are on alert to changes to interest rates and markets and planning ahead on that basis. But what we are potentially lacking in Australia is match fitness. Corporate profits have done well in the past few years, but in a number of cases not through a focus on growth. A large number of corporates have been paying down debts, restructuring and streamlining their operations and they have benefitted from low wage growth. This internal focus, while an ongoing necessity, should be done in conjunction with a view to growth.

So what can we all do to be better aware of how an interest rates change could play out?

1. Take an interest in ecosystems

What’s the current cost of doing business? Organisations should be mapping their ecosystems to understand how the consequences of an interest rate rise could play out across suppliers, customers and other parties. It’s critical to understand the inputs and outputs of the business, the sensitivity in price fluctuation changes and the practical ways to reduce exposures.

Some options?

They could include setting up alternative sourcing or supply arrangements, setting agreed prices with suppliers early on to avoid cost hikes, looking at alternative markets as well as the balance of activity between off shore and domestic. It’s about creating viable options for the future to weather any interest rate storm.

2. Focus on future growth – because not taking a risk, is a risk in itself

Having a medium to longer term growth perspective is essential. Given that we know companies are generally not highly geared, there are likely to be profits that could be extracted more effectively. Those whose profit increase has largely come from cost saving and low wage growth could be facing risks in the medium term – there are already signs that wages could soon be on the up. Companies need to have a dual focus – managing costs and strategic investments to secure higher growth. Overcoming risk aversion is key – now would seem to be a positive time to making both organic and inorganic growth initiatives.

3. Set your sights on scenario planning

As we showed in BTLC#6, scenario planning can be a really effective way to challenge your assumptions, understand key issues facing your business and mitigate unnecessary risks. Impacts of an interest rates increase is one of the scenarios we have mapped out in our Horizon tool. In the ‘China stumbles’ scenario, we show that the effects of a change to interest rates would not be equal across the board. The construction and finance industry are the most vulnerable and are particularly exposed to any rise in interest rates. Retail spending on durable goods is also likely to be affected as less houses will be built and thereafter filled with TVs, couches and toasters.

So when it comes to interest rates, it’s time to take a strong business interest.

Contact us for more information on the CFO Sentiment survey or scenario planning with Deloitte Horizon.

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