Every time the Reserve Bank of India announces the credit policy, it releases a lot of macro-economic data. Any indication of a hike or a cut can affect the functioning of a business if you rely on short-term or long-term borrowing. Understanding these effects can help you better manage your business.

Direct Effect

With an increase in the interest rate, there are a couple of prominent direct effects:

  • Cost of borrowing increases

An increase in the interest rate by RBI implies that the cost of borrowing for banks and non-banking financial companies (NBFCs) also rises. To cover these costs, the banks and NBFCs charge higher interest rates to their borrowers.

Businesses requires money to grow and expand. An increase in business loan interest rates deters them from borrowing more funds. Businesses would have to pay higher interest on existing loans as well. Thus, most businesses would shy away from borrowing.

  • Keeping your business in the green becomes difficult

Because of expensive financing options, you would have to reconsider your business expansion plans. Development of new projects could be stalled. Managing working capital could also become challenging. This can affect production lines and supply chain of goods. Thus, an increase in interest rate can cause a dent in your cash reserves leading to a decline in profits.

Also Read : All You Need To Know About Interest Rates For Small Business Loans

  • Measures to counter direct effects of rate variations

Managing outstanding payments and other expenses is likely to get difficult due to increased rates. It is, therefore, advisable to plan your expenses wisely while anticipating rate hikes. Begin with listing outstanding payments and receipts. Prioritize your payments. This could depend on the credit tenor or the cost involved in a case of delay.

Discuss with vendors if the credit period can be extended. On the other hand, try to secure money on time from the receivables. Request your customers to release the payment soon. Raise the invoices for goods/services delivered.

In the process of improving cash flow, keep a track of interest rate changes simultaneously. Avail a business loan during the low-rates period to fund your expansion plans.

Indirect Effects

Just like direct effect, an increase in the interest rates from RBI has some indirect implications as well. Increased interest rates result in a rise in customers’ interest outgo on credit cards, personal loans, home loans and so on. This leaves the customers with less money in their hands. Thus, their spending power reduces. During such times, people prefer to save money after spending the mandatory expenses. Thus, the demand for goods and services sees a decline. This decrease in sales affects the revenue of your business.

Gradually, as the customers get accustomed to the rate change. Eventually, the sales begin to increase. Besides, businesses offering products with inelastic demand remain unaffected most of the time.

Unlike direct effects, there is not much that you can do about the indirect effects.

Bottom line

Interest rates have the potential to control inflation. Thus, it is advisable to safeguard yourself against the effects beforehand.

One such measure could be to take a business loan during the low-rates period.

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