Why Do Higher Interest Rates Highlight Supply Chain Finance?

The global economy is currently navigating troubled waters. Many countries face the impending threat of recession as their economies slow down and inflation rates touch all-time highs. The crisis, caused by a double whammy of pandemic curbs, and the ongoing military escalation in Europe, has disrupted supply chains around the world, driving up the cost of goods. Central banks worldwide have increased interest rates to put a lid on rising prices.

Accessing funds through borrowing becomes more expensive for suppliers as the interest rates increase. Tightened financial conditions will create bottlenecks along the supply chain, adding to the existing cost crises. In such a time, supply chain financing (SCF) can be the most cost-effective way to access working capital in a high-interest economy.

The Economic Significance of Supply Chains

Supply chain networks consist of activities, like procuring raw materials, producing goods and services, and distributing and delivering finished products to consumers. Supply chain networks are critical to a country’s domestic and international commerce. Independent economies are well connected through international supply chains and rely heavily on such networks to import basic commodities into their markets.

According to a recent study, economic growth positively correlates with the length and depth of supply chain networks. The study was conducted by an interdisciplinary research team of experts from the University of Oxford and Harvard University. They observed that lengthy supply networks have more opportunities for innovation and for accumulating the benefits of technology upgradation. Consequently, long production chains reduce the cost of goods faster, facilitating quicker gross domestic product (GDP) growth.

Another study by MIT researchers published in 2017 considers the supply chain economy as a distinct economic category that constituted  37% of private employment in the USA for the year 2013. This category paid higher average wages to its employees, 57% more when compared to business-to-consumer (B2C) industries. Furthermore, the supply chain economy has a higher concentration of Science, Technology, Engineering, and Mathematics (STEM) jobs than other categories.

Inflation, Interest Rates, and Supply Chain Disruption: A Vicious Cycle

Governments try to control rising inflation by increasing interest rates. But the critical issue is whether this measure is effective in demand-pull inflation situations, when supply chains keep hitting roadblocks.

The cost of funds increases with high-interest rates. Consequently, accessing working capital through traditional lending options becomes more difficult for businesses. Shortage of funds will force suppliers and buyers to roll back their operations and reduce labour and inputs. This worsens inflation because the supply-demand gap widens due to reduced production, and layoffs raise unemployment rates. Supply chain financing offers a smart solution to ease the stress of rising interest rates and maintain the stability of supply chains.

Why Supply Chain Financing is Gaining Prominence in High-Interest Rate Environments

The true impact of rising interest on a business depends upon the size of the business, the industry it serves, its position within the supply chain order, and the length of the rate hikes. High interest rates could severely undermine smaller companies’ ability to survive. Some adverse effects include:

1.  Increased materials cost
2.  Shortage of inputs and products
3.  Extended average collection periods
4.  Higher borrowing costs
5.  Increased warehousing costs

Supply chain financing cushions the impact of high interest on the supply networks. Since SCF programs are for short durations and self-liquidating, they offer many advantages over conventional loans and advances.

The Merits

1. Economical means to access working capital: In the long term, borrowing working capital at higher rates will negatively impact businesses. Supply chain financing helps small firms access funds on reasonable terms.
2. Overcomes the lag in invoice settlements: Speedy settlement of invoices benefits both suppliers and vendors. Buyers can maintain their credit periods, and the suppliers get paid sooner, relieving both parties from a possible liquidity crunch.
3. Helps regularise uneven cash flows: Timely availability of cash enables small suppliers to stabilise their procurement, sales, and payments cycles. Supply chain financing helps businesses control their cash flows and maintain a healthy liquidity position.
4. Speeds up manufacturing cycles: Longer production cycles or production lead times increase the cost of production. It also causes stock-outs creating market disruptions. An adequate supply of working capital reduces lengthier production cycles.
5. Helps small firms leverage the time value of money– Inflation erodes the purchasing power of money. Hence cash received early will have more value than cash received when the invoice is settled.

Ending Notes

Physical supply chains and financial supply chains are both important to the economic progress of nations. Given the current state of affairs, it is clear that global supply chains must function smoothly to avoid recession. But the supply networks are still under pressure due to high inflation levels in many countries. According to a World Bank report, central banks will have to raise interest rates further to reduce global inflation. This means we cannot expect interest rate cuts any time soon. In such a scenario, supply chain financing is the prudent funding option needed to keep the supply conveyor belt running.

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