By Miguel Saviroff, Penn State Extension Educator, Somerset County
The Federal Reserve’s decision to increase interest
rates in December has raised questions in the farming sector. The feds have
announced at least two new hikes in interest rates in 2017. Although farm level
interest rates have been too low for a long time, low agricultural prices can’t
cover for any operational expense increases. The clear majority of non-real
estate loans made to farmers carry floating interest rates which means the cost
of credit adjusts upward if rates increase.
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| A pie chart used to compare interest expense versus gross profit |
The FRB increases the interest rate when there are
signs of a strengthening economy but often agriculture is countercyclical to
the national economy. One thing for sure is that farmers need to observe
certain signals to maintain financial efficiency.
Farmers need to monitor their interest expense ratio, the
relation between interest expense and gross farm income, which may indicate too
much dependence in borrowed capital or high interest rate on existing debt. The
Penn State “Farm$en$e” program recommends to maintain this ratio below 5%. An
Interest-Expense ratio higher than 10% indicates that the farm is spending too
much of its gross income paying interest on borrowed money. In this case a
business or farm may want to look at ways to lower this expense, this can be
accomplished in a number of ways including: selling of assets to pay down
overall debt (negative ramification for this may include tax issues),
refinancing some loans, and restructuring of debt.
Higher interest rates in a country increase the value of
that country’s currency relative to nations offering lower interest rates.
These higher interest rates attract foreign investment and the value of the
dollar increases. A strong dollar makes our agricultural products less
attractive to foreign buyers. One example is the reduction of cheese shipments
to Europe due to the decline of the euro versus the dollar.
If there was one piece of advice to the agriculture industry, it would be to settle in. While you may want to secure a long-term loan or purchase more equipment, you will want to limit your borrowing; only do so when necessary.
Likewise, be sure to have a cash reserve on hand.
With interest rates expected to further increase, you will want to ensure you’re properly prepared for the effects no matter how many hikes and in what magnitude.
