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.
|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.