Real Interest Rates and the Impact on Third Parties and Suppliers

The recent economic landscape has been a rollercoaster, with interest rates soaring and inflation fluctuating. While the focus often lies on the headline numbers, it's the real interest rate – the difference between the interest rate and inflation – that truly impacts your operation, because your suppliers and third parties are feeling the squeeze of today’s market.

Let's break it down:

Let’s say that today the following is true:

• Interest rate: 5.5%
• Inflation rate: 5.0%
• Real interest rate: 0.5%

In this scenario, even though the nominal interest rate is high, inflation was keeping pace, resulting in a minimal "real" impact on borrowing costs.

Now, let’s say that the economy begins cooling tomorrow:

• Interest rate: 5.5% (unchanged)
• Inflation rate: 3.0% (down)
• Real interest rate: 2.5% (significantly higher)

While the nominal rate remains the same, the drop in inflation pushes the real interest rate up, making borrowing more expensive. This might seem positive, but for private companies who are limited in their cash flow, it presents a challenge.

The Squeeze on Smaller Players:

Unlike larger corporations, private companies don’t have the luxury of raising prices to offset rising costs. This means that higher real interest rates bite harder, negatively impacting their cash flow.

To make matters worse, many private companies face long payment terms from their larger customers. Waiting 120 days (nearly 6 months) for payment significantly strains their cash conversion.

The Outlook:

The Federal Reserve's anticipated rate cut offers some relief, but the real interest rate will likely remain elevated throughout 2024.

What You Can Do:

• ‍Monitor the financial health of your suppliers and vendors: By keeping tabs on how your critical partners are doing financially, you can proactively manage and mitigate emerging risks.‍
• Collaborate: Transparency and open communication are key. Begin financial discussions with your partner before their financial deterioration becomes your disruption. Work with your suppliers and vendors by considering enacting early payment discounts or alternative financing options.‍
• Embrace agility: Be prepared to adapt to changing market conditions. Explore new partnerships and leverage technology to streamline your risk management program.

RapidRatings is Here to Help:

By understanding the impact of real interest rates and proactively managing your third party and supplier risk, you can navigate these challenging times. RapidRatings provides financial risk insights and supplier intelligence to empower your business decisions. Contact us today to learn more about how we can help you thrive in any economic climate.