Managing the Impact of Rising Interest Rates and Inflation

Published: May 16, 2022

With interest rates rising as central banks try to contain inflation, a difficult balancing act is in progress. The responses of the various monetary policy committees are being watched with a keen eye by treasurers the world over as they consider their next actions. Tarek El-Yafi, Regional Head of Cash Management Sales, and Karen Hom, Managing Director of Transaction Banking, Standard Chartered, share their views on the impact of the current inflationary cycle with TMI.

Inflation is rising, and with it, interest rates, as central banks try to keep a lid on outcomes forced largely by rising global food and energy costs. Rate rises do not happen in isolation and so the potential consequences of geopolitical actions such as the war in Ukraine must be part of the equation for companies trying to gauge their best next step. As events unfold and treasurers begin to assess the impact of events, the key to success will be flexibility, says El-Yafi.

With interest rates rising in the US to record highs, the dollar is becoming more expensive, pushing up the cost of borrowing. Naturally, when it comes to managing the balance sheet, and working capital in particular, corporates are looking to optimise on both debt and investment sides, El-Yafi notes.

Interest rate hikes in the US have been minimal so far (75bps), but the expectation is for up to six more throughout 2022 and the end-point is not yet clear. While corporates are “not in panic mode”, El-Yafi believes many have been assembling and refining their optimisation plans for the key elements of their interest-rate story.

Taking a wider international perspective, Hom sees a different narrative unfolding across Asia and Europe. Globally, central bank responses have been uneven, she notes. The Bank of England, for example, raised rates ahead of the US Federal Reserve. This served to alert corporates of the need to prepare for action elsewhere.

However, in Asia, notably China, rates are lowering, she says. “The global disparity in response has created a continued push by companies to move excess liquidity out of markets where they either consider yields to be too low, or their cash to be trapped, and into markets, such as the UK and the US, where they now have a greater need for cash.”

Early responders

The onset of the Covid-19 pandemic had already seen many corporates reconsider the meaning of “adequate liquidity” in the US, says El-Yafi. With balance-sheet optimisation firmly on the agenda, he notes that corporate preparedness “for the next crisis” is now heightened, with many “seeking not to be burdened with expensive liquidity on their books”.

Indeed, while the pandemic remains a threat, the anticipation and realisation of interest rate rises has motivated a burst of corporate liquidity planning activity, notes Hom. And now new and unforeseen factors, especially the war in Ukraine, are intensifying that focus. “With these additional risk factors, we’re seeing even more urgency in liquidity planning, and corporates are increasingly turning to their banks for ideas.”

Of course, some businesses are passing on their increasing costs, including interest rate rises, to customers, says El-Yafi. “But we’ve also noticed record amounts of supply chain finance being implemented recently. It’s being used to plug the gaps, enabling buyers and suppliers to optimise their own working capital positions and maintain supply chain resilience.”

Investment reviews

As events unfold, and corporates consider their best plans of action, Hom is seeing changes to investment strategy emerging. “We’ve noted risk profiles shifting slightly,” she comments. “Not only are some clients willing to go longer on the yield curve, but they are also considering investing in bond funds now that those rates are rising.”

Noting that many clients are reassessing their longer-term investments too – they do not wish to be locked in at a lower rate – El-Yafi sees a shifting stance on instrument and tenor options. With rates rising, he says “many of our clients are keeping their cash short”. While bank deposits remain the preferred option, he notes “some money market instruments are being discussed for the first time in a long time”.

As economic uncertainties continue to unfold, more companies are readying themselves by spinning off those parts of their business that are inefficient or no longer considered core business. The corollary of this, says Hom, is that a watching brief is also being maintained on possible bargain acquisitions.

“This is an unusual environment where money is becoming more expensive to borrow, but yields on equity purchases are still over-valued for many businesses,” she notes. “It means more companies are looking out for potential takeovers; they’re just waiting for those yields to fall as interest rates rise.” Heightened M&A activity is likely to further incentivise cash efficiency planning as companies prepare their war chest for a rapid strike.

Bigger toolkit

With the cost of the dollar over the past couple of years being almost zero, many corporates were less focused on driving efficiencies and unlocking cash in internal operations, notes El-Yafi. But with interest rates rising, that focus is returning quickly.

This is where new technologies, notably APIs, come into play as agility, and the associated rapid aggregation of data, become essential. “Where instant payment schemes are available, real-time information around AP and AR flows is helping to enhance cash visibility and, ultimately, the liquidity of the business,” he states.

The difference made by APIs can be seen “even around the edges of business”, adds Hom. In the logistics space, for example, she says facilitating collection-on-delivery via API-enabled confirmation of payment helps speed up cash collections and reconciliations. Such simple and easily implementable working capital advantages have not gone unnoticed by cash-hungry businesses. “We’ve been investing in APIs for many years and we’re just now seeing a huge uptick in interest globally,” she notes.

While banks, SWIFT and the wider fintech community are clearly enabling corporates to achieve more efficient liquidity structures locally, regionally, and globally, most economies are still at an early stage of this interest rate cycle. There is a limit to the costs that can be passed onto customers, and so it is incumbent upon each business to find other ways to mitigate the impact of interest rate and inflation rises.

This is where finance, and treasury in particular, has a vital role to play in balance-sheet optimisation, El-Yafi concludes. Technology clearly also has a key part in this scenario, but strong liquidity planning, re-evaluation of investment strategies, reviewing cash collection cycles, and even spinning off non-core or underperforming entities, are all vital elements of the process to improve corporate financial resilience.