A significant number of economists and financial experts have forecasted a notable rise in bankruptcies and interest rates in 2022 after a dramatic drop in 2021 according to the Federal Reserve.
In this article, we will discuss the expected interest rates and bankruptcies in 2022. Most importantly, we will assess the relationship between the two to determine if the anticipated growth in interest rates will lead to an increase in the number of individuals and businesses declaring bankruptcy in the upcoming months.
Interest Rates in 2022 and its impact
It is highly expected the Federal Reserve will raise interest rates by a minimum of 0.25% due to the increased inflation rate after the stimulus programs are shut down by the end of the year. The increased interest rates are necessary to mitigate inflation at the rate of approximately 2% and keep personal consumption expenditures inflation under control.
Sometimes even just the talk about rising interest rates has a similar effect to actually increasing rates as forward-looking people cut down their consumption level and profit-oriented sellers have the urge to start selling at a faster rate. As a result, it will slow down the market to a certain extent.
The outlook north of the border is the same. The Bank of Canada announced in October the end of its Quantitative Easing program, which was implemented at the start of the pandemic. This program helped to stimulate the economy by keeping the cost of borrowing for Canadian households and businesses low, bidding up the price of government-issued bonds and lowering their return, which in turn flowed through to lower interest rates on mortgages and business loans, encouraging borrowing and spending.
Even though the Bank of Canada is winding up the program, it has been confirmed the Canadian economy still requires significant monetary policy assistance and that interest rates will starting rising in Q2 and Q3 of 2022.
The increased interest rate will put significant pressure on households in Canada where statistically, household debt is $1.77 for every $1.00 of disposable income. Therefore, demand for debt consolidation will be on the rise with increased interest rates which proliferates the use of credit cards even more.
Bankruptcies in 2022
As the increased interest rate forces people to cut down their spending, a severe slowdown is expected in the supply chain which will eventually bring about inventory deficits and factory shutdowns.
Smaller, less stable companies are much more likely to declare bankruptcy in 2022 as they are more vulnerable to changes in interest rates, especially after governments shut down COVID-19 support measures which helped them keep afloat during the pandemic.
Increased interest rates will inevitably have a similar impact on some households and it will lead to more bankruptcy filings on a global scale.
Global bankruptcies are expected to increase by 33% in 2022 (the change will have a notable impact on insolvencies in some parts of Europe such as Belgium, Switzerland, Italy and Norway) and the less stable companies that were saved from insolvency by government support programs in 2020-2021 are expected to collapse.
Following the termination of fiscal support, the government will have to raise interest rates and businesses will face difficulties as a result of these circumstances leading to the bankruptcy of less stable businesses.
Russia, Brazil, and Turkey have already ended support; Sweden and Australia have extended it to the end of 2021 and South Korea will shut off support after the first quarter of 2022.
Correlation between Interest Rates and Bankruptcies
Increased interest rates boost debt expenses for businesses and diminish their value by lowering the present value of future earnings. As a result, the likelihood of bankruptcies will increase.
Changes in interest rates influence a variety of significant elements including real estate prices, competitiveness and bank loan losses; all of which have a strong correlation with the number of bankruptcies on a worldwide scale. All of these variables have an impact on the exchange rate and local costs in relation to international expenses; both of which are critical for financial stability.
Other than a straightforward correlation between insolvencies and interest rates, bankruptcies largely depend on GNP which is principally impacted by the inflation rate. One of the most essential determinants of inflation level is the interest rate, so there are direct and a plethora of indirect effects of interest rates on bankruptcies. The expected level of impact is indefinite as it depends on various other determinants.
In summary, a considerable number of economists believe bankruptcies will increase with interest rates in 2022, but it needs to be noted that all forecasting is subjective.
The increased interest rates will most of all affect fragile businesses and households that are about to exit support programs at the end of 2021 or in Q1 and Q2 of 2022, as their cost of loans will skyrocket. As a result, the number of insolvencies will rise as some of the less financially stable companies and households are anticipated to declare bankruptcy.
The preceding blog was a guest post graciously provided by Arthur Dubois of hardbacon.ca.