IMPACT OF HIGH INTEREST RATES ON COMPANIES

Interest rates represent the cost of borrowing, or the cost of obtaining money.

The main interest rate is set by the RBI. This is known as the base rate.

How do interest rates affect companies?

High interest rates affect companies because they influence both their own costs and the ability of their customers to borrow and spend.

SAVINGS
High interest rates make saving more attractive. Companies receive a higher return on their savings accounts and cash-like investments. The combination of high costs to borrow and high return on savings are an effective deterrent to spending disposable income on nonessential items. Most savvy consumers are willing to earn high rates on savings and spend when rates are low. Businesses also must reevaluate the utility of investing money, and the margin of return they can receive from doing business.

INTEREST RATES IN INDIA

AD/AS diagram showing impact of Interest rates on AD

Higher interest rates affect people in different ways. Higher interest rates do not affect each consumer equally. Those consumers with large rents will be disproportionately affected by rising interest rates. For example, reducing inflation may require interest rates to rise to a level that cause real hardship to those with large rents. However, those with savings may actually be better off. This makes monetary policy less effective as a macro economic tool.

Real interest rate- It is worth bearing in mind that what is important is the real interest rate. The real interest rate is nominal interest rates minus inflation. Thus if interest rates rose from 5% to 6% but inflation rose from 2% to 5.5 %. This actually represents a cut in real interest rates from 3% (5-2) to 0.5% (6-5.5) Thus in this circumstance the rise in nominal interest rates actually represents expansionary monetary policy.

It depends whether increases in the interest rate are passed onto consumers. Banks may decide to reduce their profit margins and keep commercial rates unchanged.

EFFECT OF HIGH INTEREST RATES

• Immediate Effects
• Mid-term Effects
• Longer-term Effects

Immediate Effects-
The types of businesses most immediately impacted are those that require frequent borrowing.

Midterm Effects-
As rates increase, consumers find their cost of borrowing goes up as well.

Longterm Effects-
Many businesses, of course, are not dependent on end consumers for their profits.

REFERENCES

• http://www.ehow.com/about_5335904_do-interest-rates-affect-businesses.html
• http://www.economicshelp.org/macroeconomics/monetary-policy/effect-raising-...

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