How High-Interest Rates Affect Entrepreneurs

How High-Interest Rates Affect Entrepreneurs

The rise in inflationย has triggeredย #centralbanksย globally to increase interest rates. Although this monetary action prevents currency devaluation, it is detrimental to entrepreneurs who rely on external financing for business growth. Let me explain.

As interest rates increase, founders who want to raise capital must give a higher percentage of their pre-tax profits as interest expenses. In addition, if the borrower’s credit rating is less, which is evident for start-up burning cash, lenders charge higher interest rates to account for the default risk.

At higher interest rates, the interest expenses rise, resulting in a higher percentage of profits going to lenders, demotivating borrowers to work hard.

For instance, if a founder has
Cash on hand = A
Investment needed for the project = I

Then, the founder raises ๐ˆ-๐€ ๐š๐ฌ ๐š ๐ฅ๐จ๐š๐ง ๐Ÿ๐ซ๐จ๐ฆ ๐š ๐ฅ๐ž๐ง๐๐ž๐ซ.

If cash flows from project = R and
Ph is probability R>0; PL is the probability R<0, and
R = RL+RB, where RL is the cash flow to the lender and RB for the borrower

At higher interest rates, even when R>0, most profits go as interest expenses to the lender, and the borrower gets fewer profits for his effort. Thus, the borrower has incentives to consume cash for his benefits. If B is the private benefit,

At PL->R<0, payoff = 0 for borrower and lender

When R>0,

the lender would receiveย  ๐๐ก*๐‘๐‹=๐ˆ-๐€ ๐š๐ง๐

If i is the interest rate for a loan,

Cash flow for Lender RL= (1+i)*(I-A)

Substituting I-A to Ph*RL gives

(๐Ÿ+๐ข) = ๐Ÿ/๐๐ก

If Ph=1, i=0 implies that the project invested is a risk-free project.

As Ph->0, i->infinity implies that the interest rates rise with low NPV projects.

At PL, where R<0, interest rates rise, borrowers get motivated to consume cash for their benefits resulting in higher default

Thus, as interest rates rise, higher NPA increases the chances of scams.

As long as we ๐๐จ๐ง๐ญ ๐ซ๐ž๐ฌ๐ญ๐ซ๐ฎ๐œ๐ญ๐ฎ๐ซ๐ž ๐๐ž๐›๐ญ ๐Ÿ๐ข๐ง๐š๐ง๐œ๐ข๐ง๐  ๐Ÿ๐ซ๐จ๐ฆ ๐œ๐จ๐ง๐ญ๐ซ๐š๐œ๐ญ๐ฎ๐š๐ฅ ๐œ๐ฅ๐š๐ข๐ฆ๐ฌ ๐ญ๐จ ๐ซ๐ž๐ฌ๐ข๐๐ฎ๐š๐ฅ ๐œ๐ฅ๐š๐ข๐ฆ๐ฌ, ๐ก๐ข๐ ๐ก๐ž๐ซ ๐ข๐ง๐ญ๐ž๐ซ๐ž๐ฌ๐ญ ๐ซ๐š๐ญ๐ž๐ฌ ๐š๐ซ๐ž ๐๐ž๐ญ๐ž๐ซ๐ฆ๐ข๐ง๐š๐ง๐ญ๐š๐ฅ ๐ญ๐จ ๐ž๐ง๐ญ๐ซ๐ž๐ฉ๐ซ๐ž๐ง๐ž๐ฎ๐ซ๐ฌ๐ก๐ข๐ฉ, ๐ฃ๐จ๐› ๐œ๐ซ๐ž๐š๐ญ๐ข๐จ๐ง, ๐š๐ง๐ ๐†๐ƒ๐ ๐ ๐ซ๐จ๐ฐ๐ญ๐ก.

If we fail to do that, we need to control inflation to manage interest rates, or the real growth rate should exceed inflation so that high growth projects compensate for rising interest rates.

๐˜ฟ๐™ž๐™จ๐™˜๐™ก๐™–๐™ž๐™ข๐™š๐™ง – ๐™„ ๐™™๐™š๐™ซ๐™š๐™ก๐™ค๐™ฅ๐™š๐™™ ๐™ฉ๐™๐™š ๐™–๐™—๐™ค๐™ซ๐™š ๐™š๐™ฆ๐™ช๐™–๐™ฉ๐™ž๐™ค๐™ฃ ๐™—๐™ฎ ๐™–๐™ฃ๐™–๐™ก๐™ฎ๐™ฏ๐™ž๐™ฃ๐™œ ๐™—๐™–๐™ฃ๐™ ๐™ž๐™ฃ๐™œ ๐™จ๐™˜๐™–๐™ข๐™จ ๐™ž๐™ฃ ๐™„๐™ฃ๐™™๐™ž๐™–, ๐™–๐™ฃ๐™™ ๐™ฉ๐™๐™ž๐™จ ๐™š๐™ฆ๐™ช๐™–๐™ฉ๐™ž๐™ค๐™ฃ ๐™ฃ๐™š๐™š๐™™๐™จ ๐™–๐™ฃ ๐™ช๐™ฅ๐™™๐™–๐™ฉ๐™š ๐™ฉ๐™ค ๐™จ๐™–๐™ฉ๐™ž๐™จ๐™›๐™ฎ ๐™–๐™ก๐™ก ๐™˜๐™ค๐™ฃ๐™™๐™ž๐™ฉ๐™ž๐™ค๐™ฃ๐™จ. ๐™ƒ๐™ค๐™ฌ๐™š๐™ซ๐™š๐™ง, ๐™ฉ๐™๐™š ๐™›๐™ช๐™ฃ๐™™๐™–๐™ข๐™š๐™ฃ๐™ฉ๐™–๐™ก ๐™ง๐™–๐™ฉ๐™ž๐™ค๐™ฃ๐™–๐™ก๐™š ๐™ง๐™š๐™ข๐™–๐™ž๐™ฃ๐™จ ๐™ฉ๐™๐™š ๐™จ๐™–๐™ข๐™š.

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