Interest rates - The 'Dark' side

It should not have come as a surprise to anyone that the Governor of the Reserve Bank hiked interest rates by another 50 basis points in mid-August, with warnings that more may yet follow.

However, we should not lose sight of the dire impact this is going to have on business.  Obviously the immediate factor that most people will consider is spending power but, besides the effect it will have on the man in the street and ultimately on retail turnovers, little thought is given to the mainstream businesses in the South African economy: the manufacturing and wholesale sectors.

Input costs escalate, stock holdings immediately cost more, working capital is effectively reduced, overdraft facilities cost more or may even be reduced by the financier, additional security may be called for and bottom line profitability is impacted.  So-called interest cover and company gearing is immediately affected.  Add to this the effect that the volatility of the JSE has on a companys investments or own share price for that matter. And, if the cost of money becomes too expensive for a company, an inevitable conclusion to reach is that expenses, somewhere in the organisation, must be cut in order to maintain profitability. Invariably, when economic activity is booming, sales grow and possibly additional staff are recruited but the first expense to come under scrutiny when times get tough are staff costs. Lay-off's/retrenchments are the likely first step to take.

While there is a need to curb consumerism and cool over-exuberant demand, there is also the ensuing loss of jobs, jobs that the government has so steadfastly been trying to encourage business to provide.  If one now factors in the costs associated with the recent and current wage negotiations, resultant loss of man hours, production and orders, it is not inconceivable to expect that there are a number of companies which, as a result of not being able to repay creditors, will be forced into liquidation. This is a very real but sad possibility of an increasing interest rate regime, creating even more strain on retrenched Joe Citizen, whose ability to service personal debt now will be nullified. Credit cards, car loans and mortgages will all be impacted and a new cycle of black listing may emerge.  Certainly the fact that we are coming from a situation of all but historically low interest rates, lessens the strain somewhat. However, someone with a R750 000 bond and car loan of R200 000, will now have to find almost R2 000 more after-tax money to service such debts.

Admittedly formal company liquidation and personal sequestration data are yet to reveal the ultimate impact of this deteriorating environment. Company closures in the first half of the year are in fact 7% lower than in January to June 2006 and debt judgments paint a similar unaffected picture at present.

But experience at Credit Guarantee (CGIC) hints that the tide may be turning. Requests for payment extensions and re-negotiation of payment terms are all the rage at present, with notices on overdue accounts substantially up in the first half of 2007. This is normally a harbinger of a period of higher claims for CGIC, as firms begin to default on paying for orders placed. Ultimately, this is a precursor to higher levels of failing firms.

So the Governor is faced with a conundrum: the need to keep the inflation outcome below 6% without unduly curbing the economy's ability to grow, assisted by adequate access to reasonably priced debt.  But the South African Reserve Bank has a mandate.  More worrying are calls for higher inflation and lower interest rates in the face of such unbridled, reckless spending.

The last three years have spawned real increases in disposable incomes of 6.3%, 6.3% and 6.7% respectively, achieved wholly on the back of structurally lower inflation. The five-year period prior to that (1999-2003) saw real disposable incomes rise 3% per annum on average. This gear change is what fostered the higher demand in the economy and saw the living standards of many improve markedly. We cannot allow inflation of 8-12% to bedevil our prospects, while at the same time we need to foster job growth and investment. Businesses will need to keep abreast of tightening developments if they are to avoid the pitfalls noted above.

Luke Doig, Senior Manager Economics, Credit Guarantee Insurance Corporation