Impact of Rising Interest Rates on Retail Sector

The retail industry has been financially struggling for a significant amount of time now. This struggle has been exacerbated by multiple factors. However, post 2022, a new and important macroeconomic variable has changed which has further accelerated the financial troubles which are being faced by the retail industry.

For the past decade or so, the Fed and other central banks across the world have followed an expansionary monetary policy. This meant that credit was easy and inexpensive to obtain. This expansionary policy saw its peak during the 2019 covid crisis. As a result of excessive expansion during that period, central banks have witnessed runaway inflation in many parts of the world. Hence, in order to overcome this inflation, the Fed has raised interest rates significantly.

These increased interest rates have impacted almost all sectors of the economy. The retail sector has been no different. There has been a significant negative impact of rising interest rates on the retail sector. The details of these negative effects have been listed below:

1. Lower Disposable Income: The average American as well as the global consumer is indebted towards banks. This means that they have a mortgage payment, car payments, education loan payments and many other such payments to make. Also, many consumers fund their purchases with consumer loans or credit cards.

   The cost of all these loans is tied to the interest rates set by the central bank. Hence, if a central bank raises the interest rate, the amount of money from the consumer’s salary which is allocated towards these loans increases considerably.

   Now, since their salary is fixed and an increasing amount of money is going towards servicing of these loans, these consumers have a lower disposable income. A lower disposable income translates to lower sales for retailers. This is one of the reasons that retail companies around the world are struggling financially.

2. Consumers are Incentivized to Save: Consumer behaviour is significantly influenced by the central bank’s interest rate policies in the long run. This is because of the fact that when interest rates rise, consumers are incentivized to save a larger portion of their incomes. This means that they want to invest this income for larger future gains. On the other hand, when the interest rates are lower, consumers prefer to spend money immediately instead of the future.

   The higher interest rates have started incentivizing people to save and invest larger amounts of money. This is in stark contrast with the earlier philosophy of borrowing and spending more money since credit was cheap. Increased consumer savings also mean that fewer people are actually purchasing retail products.

3. Negative Consumer Sentiment: The retail industry is not the only industry which has been impacted by increased interest rates. Other industries such as technology and finance have also been significantly impacted. This also means that a large number of people with high paying jobs in these sectors have seen either a pay-cut or a layoff.

   If consumers have not been directly impacted by these events, they know of people who have been impacted. There is a general pessimism about how the economic scenario is likely to play out in the future. This is the reason why many consumers have started deferring their purchases. The end result is that the sales in the retail sector are taking a hit.

4. Increased Carrying Costs: Increased interest rates have not only impacted the consumer. It has also significantly impacted the larger retail companies. This is because of the fact that retailer use short term credit in order to meet their operational expenses. Hence, retailers are witnessing an increase in their operational as well as carrying costs. Since a lot of these retailers are already under significant debt, they are unable to obtain short term loans at reasonable interest rates. Also, since the sales have already started declining, there is a build of inventory which needs to be financed with loans at higher interest rates. This is particularly true of high value luxury items.

5. Inability to do Deep Discounting: The entire retail industry is feeling the pressure of reduced sales. As a result, they are under pressure to do deep discounting and move out inventory which they have been stuck with for a long time. However, since all retailers are vying for the same reduced share of the consumer’s disposable income, they need to heavily discount in order to get consumer interest.

   However, since the financials of these retailers are already under increased pressure, they are not able to do so. This is creating a situation wherein the margins of the retailers are increasingly coming under a lot of pressure.

6. Expansion Plans: Retailers need to constantly invest in expanding their business. This expansion could be in the form of increased product lines, increased number of stores and so on. Almost all retailers also need to invest heavily in upgrading their technology. All of these investments require capital outlay. This capital is now available at a higher rate of interest.

   Also, as mentioned above, the margins in the retail sector are also under pressure. This means that the retailers do not have the cash flow required to make timely repayments for these loans which are being undertaken. Lenders are also aware of this situation. This is the reason that the number of lenders who are willing to lend have also been reduced.

It is evident from the above-mentioned points that the rising interest rates have exacerbated the already dire situation in the retail industry. At the present moment, the retail industry is running out of options to weather this storm.