Changes in TAXation and high interest rates affect businesses differently.
Generally, businesses that produce non-essential products such as fancy electronic gadgets, luxury overseas holidays, sports cars, expensive jewelry, etc. are the most affected. It is simply because people can live and survive without those luxury goods and services.
Businesses that produce essential goods and services (normal products and inferior products) such as food and water, clothes, medications, etc. are the least affected by such changes. It is simply because people cannot live and survive without those essential goods and services. People will need to buy them no matter how expensive they become.
Impact on customers:
With high interest rates, the cost of borrowing money increases, so people will borrow less from the bank. People will have more incentives to save, therefore they will spend less money.
- Lower disposable incomes. An increase in interest rates is likely to reduce consumption and investment expenditure, therefore being a threat to businesses that will face lower demand leading to lower sales revenue. If consumers borrowed money to buy homes, then their available incomes would be reduced. Therefore, demand for goods will decrease because consumers will have less money to spend.Â
- Less new loans. Borrowing money from the bank is now less attractive because households face higher interest repayments on their loans. People’s disposable income after all interest-bearing loans have been paid is reduced.Â
- Existing loans more expensive. Those households with existing credit card bills, personal loans and house mortgages now face escalating interest repayments, and may need to reduce their overall spending.Â
Impact on businesses:
With high interest rates, the cost of borrowing money increases, so businesses will borrow less from the bank. Businesses will have less capital to invest for expansion.
- Lower demand for products. An increase in interest rates reduces consumer borrowing and this reduces demand for goods bought on credit, e.g. houses, cars, home appliances, electronics, etc. If consumers borrowed money to buy homes, then their available incomes would be reduced. Therefore, demand for goods will decrease because they will have less money to spend. Consumers will be unwilling to borrow money to buy expensive items, therefore companies which make luxury products will face lower demand.
- Slower business expansion. Managers may delay decisions to expand their businesses using borrowed money. Therefore, there will be less business activity in the country. Also, because of lower retained profits, companies will have less of their own resources to invest back into the business.
- Lower profitability. An increase in interest rates increases interest costs and reduces profits for businesses that have very high debts. Companies with existing corporate loans will have to pay back more interest to the banks, so their Net Profit After Interest and TAX will be reduced. Therefore, dividends and retained profits will decrease.
Impact on the country:
High interest rates in the long term, may lead to slower economic development.
- Slower economic growth. Reduced business activity will lead to slow economic growth.
- More savings from foreigners. High rate of return from savings will encourage individuals and financial institutions from other countries to invest their money with the banks in the domestic country. An increase in interest rates tends to stimulate demand for the currency since foreign investors are attracted by better returns on their savings. If China has relatively higher interest rates than the U.S., then demand for Renminbi would tend to rise thereby increasing the price of the Chinese currency. Therefore, Renminbi will appreciate against USD.
- Appreciation of local currency. Higher interest rates in one country will encourage foreign banks and individuals to deposit capital in that country causing higher demand for that country’s currency, so the exchange rate will rise. This strengthens the national currency and leads to exchange rate appreciation.Â
- Cheaper price of imports. Higher interest rates in one country will encourage foreign banks and individuals to deposit capital in that country. It will cause higher demand for this country’s currency, so the exchange rate will rise. This will make imports cheaper.
- Higher price of exports. Higher interest rates causing appreciation of the domestic currency will make the price of exports to be relatively higher, therefore it will likely reduce the demand from abroad for exported products. Hence, higher exchange rates tend to be a threat for domestic export businesses in the long run.Â
