Higher interest rates threaten to choke off investment spending by Canadian companies, with one-third of businesses warning even a two-percentage-point jump in borrowing costs would derail their growth plans and put their companies at risk, according to a new survey of mid-sized firms.
The poll, conducted by accounting firm KPMG, highlights the tightrope the Bank of Canada must walk as it tries to bring rising consumer prices under control without strangling a recovery, particularly since the central bank has said a robust revival in business investment will be critical to supporting Canada’s economy as the COVID-19 pandemic recedes.
Fifty-five per cent of companies said a one-percentage-point increase in the prime lending rate would put “material, substantial or considerable pressure on their business and cash flow” the survey of business leaders from more than 500 companies in early February found.
Companies in the consumer and retail space were most vulnerable, with 62 per cent saying their cash flows would come under pressure, while just 27 per cent of business leaders in the manufacturing sector shared that concern.
When business leaders were asked what level of increase in borrowing rates would jeopardize their growth or investment plans, 11 per cent said a one-percentage-point increase would mark a tipping point for them, with that share rising to 33 per cent should their borrowing costs go up by two percentage points.
“It’s surprising when you look at the stress level people have with a 1.5 to two [percentage point] increase in rates, but we’ve lived in a world of low interest rates for so long,” said Paul van Eyk, national leader of KPMG’s restructure and turnaround services in Canada.
The Bank of Canada raised its policy interest rate by 0.25 percentage points earlier this month to 0.5 per cent, its first rate increase since 2018. Many forecasters expect the rate hikes to continue, despite the uncertainty brought on by the war in Ukraine, since inflation has shown little sign of slowing. Economists at Scotiabank expect Canada’s policy rate to hit 2 per cent by the end of the year, rising to 2.5 per cent next year.
Unlike in past rate-hike cycles, companies have fewer levers to pull to relieve the pressure on their bottom lines, Mr. van Eyk said.
“You can’t lay people off because you’re just trying to hold on to the people you have, your supply chain is in chaos and then you add in all the geopolitical events and the pandemic,” he said.
“You have this perfect storm brewing where, historically, companies weren’t facing such a level of chaos in the markets when rates increased.”
One concern facing the Canadian economy as interest rates rise is corporate debt. Canadian companies were already carrying large debt loads before COVID-19 and have borrowed heavily throughout the pandemic.
Offsetting that is the large cash holdings that companies have amassed, thanks to the cheap cost of debt and strong corporate profits during the pandemic.
Mr. van Eyk said it’s too early to know whether the headwinds from higher rates, supply chain disruptions and geopolitical uncertainty will cause companies to struggle with their debt, but signs of stress will show up first in the loan loss reserves at Canada’s big banks.
In a note Friday, debt rating agency Fitch Ratings said provisions for loan losses at the banks increased during their first fiscal quarter of 2022, but remained well below historical averages. Impaired loans were more than 25 per cent below prepandemic levels, Fitch said.
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