The impact of interest rate hikes on South Africa’s SME sector

Business owners have had to manage the decrease in consumer spending, while many have also had to put growth plans, including hiring new staff, on hold due to the rise in the cost of doing business. Picture: Karen Sandison Independent Newspapers

Business owners have had to manage the decrease in consumer spending, while many have also had to put growth plans, including hiring new staff, on hold due to the rise in the cost of doing business. Picture: Karen Sandison Independent Newspapers

Published Dec 10, 2023

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In 2023, South Africa’s small and medium-sized enterprises (SMEs) found themselves facing a formidable challenge following a string of repo rate hikes.

These hikes pushed the interest rate to a high of 8.25% in May, where it stayed throughout the latter half of the year.

These increases, from the perspective of the South African Reserve Bank, was a weapon used to try and control inflation and stabilise the economy. However, it had huge impacts on businesses across the country.

The repercussions of the escalating interest rate on local businesses, particularly SMEs, have been profound.

Business owners have had to manage the decrease in consumer spending, while many have also had to put growth plans, including hiring new staff, on hold due to the rise in the cost of doing business.

The energy crisis has added to the challenges, forcing SMEs to find capital to invest in alternative power supply units, create new ways of working to navigate load shedding, and trying to remain productive with fewer hours in the day.

Elevated interest payments on borrowed finance impacted the bottom line.

For SMEs already operating on tight budgets, the higher costs impacted their profitability and hindered investment in growth initiatives.

In South Africa, SMEs make up 91% of formalised businesses, provide employment to about 60% of the labour force and their total economic output accounts for roughly 34% of GDP.

When SMEs suffer, the country suffers.

“Our SMEs have been tenacious in finding innovative solutions to keep their businesses alive and contribute to the local economy,” Miguel Da Silva, the managing executive of Retail Capital, a division of TymeBank, said.

“SMEs carry the burden of the nation’s prosperity on their shoulders, and a lack of growth within this sector means a lack of growth for the economy as a whole.”

South Africa’s SMEs are nothing if not resilient: the country boasts between 2.5 and 3.4 million SMEs operating today, having come through yet another difficult trading year.

“It is the perseverance of South Africa’s SME owners that keeps the doors open, the tills ringing and the hope for a stronger outlook alive,” Da Silva further said.

Testimony to the never-give-up approach of our SMEs, the Mastercard SME Confidence Index of September 2023 showed that while 86% of SMEs in South Africa are concerned about the rising cost of doing business in 2023, and 79% about inflation, more than half of micro and small businesses are optimistic about the next 12 months.

This is substantiated in the State of South African Small Business Report 2023, showing that more than 95% expect to survive the coming year, and almost 90% the next five years.

According to the Mastercard SME Confidence Index, the main concerns of SMES are: the steep incline in the cost of goods and services (86%); long-term effects of the pandemic (71%); the rising cost of doing business (86%); and insufficient access to credit (43%).

The impacts of interest: financing assets

The ripples of the 2023 interest rate hikes extend throughout SME operating costs, particularly in financing crucial assets such as company vehicles, fleets, commercial properties, and wholesale product acquisitions.

In businesses relying heavily on logistics, the rise in interest rates can lead to higher financing costs, translating into a substantial increase in operational expenses.

This domino effect is felt not only in direct financing but also in the maintenance and fuel costs associated with ageing and new fleets, requiring a delicate balance between operational efficiency, cost-effectiveness, and belt-tightening.

For SMEs looking to expand their physical footprint, the uptick in interest rates often results in more expensive development costs, increased mortgage rates, or higher rental prices. This poses a substantial burden for businesses in sectors heavily reliant on a physical presence, such as retail or manufacturing.

Procurement of wholesale products is a fundamental part of doing business for many SMEs, and higher interest rates lead to increased borrowing costs for businesses looking to stock up on inventory.

This, in turn, affects pricing strategies and competitiveness in the market. These businesses have little choice but to absorb these additional costs or pass them on to consumers, risking potential shifts in demand or loss of customers.

“There is an intricate web of economic forces that our SMEs must understand and master, to be able to operate with agility and effectiveness. Financial strategies need to be adapted and revisited often, to ensure resilience and sustainability in the face of fluctuating interest rates,” Da Silva said.

The impacts of interest: consumer spending

One of the most significant challenges facing SMEs is managing the reduced spending of their customers.

South African consumers, hit hard by relentless cost-of-living increases and soaring interest rates, have far less disposable income available, impacting SMEs’ sales and revenue.

Rising interest rates mean the cost of credit also rises, and inflation means that the cost of living is also going up. When these factors combine there is more and more pressure on consumer spending, so small business owners need to be in a position to adapt offerings and pricing accordingly. Finding a delicate balance in pricing for goods and services becomes crucial as customers grapple with financial constraints.

Da Silva said that mastering the science of setting the right price points for your products and services will help you grow your business, maintain a healthy cash flow, and drive profitability.

The state of interest rates directly shapes the financial conditions under which SMEs operate.

By influencing the cost of capital, access to finance, consumer spending, currency dynamics, and investor confidence, interest rates play a crucial role in determining the growth opportunities for SMEs in the country.

Policymakers must carefully consider these dynamics to create an environment conducive to the sustainable growth of small and medium-sized enterprises.

BUSINESS REPORT