Impact of U.S. Fed rate cuts to Singapore SMEs

The recent decision by the U.S. Federal Reserve to cut interest rates by half a basis point has sent ripples through the global financial markets. This is the first rate easing in 4 years as the U.S. battles rampant inflation post Covid. 

The impact and ramifications of USA’s rates cut on SMEs could be manifold. Let’s discuss what we foresee are some of these impacts on local SMEs, and how SMEs could mitigate these impacts as well as identifying opportunities. 

Borrowing Costs for SMEs

The most immediate and obvious effect of the Fed's rate cut decision is a reduction in borrowing costs. However, the impact on Singapore's SMEs financing costs may not be as straightforward .

While mortgage rates tend to adjust quickly in response to changes in market rates, small business lending rates in Singapore are often more “sticky”. This means that while the Fed's actions might lower overall market rates, SMEs may not experience immediate reductions in their borrowing costs.

Interest Rate Responsiveness

Housing loan mortgages in Singapore are typically pegged to the Singapore Overnight Rate Average (SORA), which reflects market conditions more closely. As SORA decreases due to the Fed's cut, homeowners with floating-rate mortgages will see lower monthly payments almost immediately. In contrast, SMEs servicing business loans may not see similar reductions right away, as banks often take longer to adjust their SME lending rates.

We observed that SME lending rates are less responsive and do not move in relative tandem to general market interest rates movement. Possible reasons why so:

1. Most unsecured SME loans are typically “fixed rate” facilities where interest is fixed for 3 to 5 years. Interest rate locked into would then be the prevailing rate back when SME borrowers applied for the loan. From our knowledge on the ground, there are no unsecured term loan facilities on floating rates for the small business lending segment in Singapore.

   The exception would be trade financing facilities, a revolving credit line where interest rates are usually pegged to a floating board rate. Therefore, most SMEs servicing current loans would not see any reduction in loan servicing costs.

2. Most SMEs are price takers in the small business banking segment. In the bank’s perspective, housing loans are a much more attractive and compelling product than unsecured SME business loans, since there’s hard collateral pledged in favor to the lender and loan quantum are typically larger.

   Larger SMEs that are served under the banks’ corporate banking or commercial  banking segments  typically require collateral for facilities offered. Unsecured SME loans bear higher risk, with NPL (non performing loans) ratio at almost 3% in 2023 for the SME segment, while the overall banking sector’s NPL ratio is just 1.7% around the same period. Therefore, there is less competition in the unsecured SME financing segment, and banks usually move rates downwards slower in relative to other segments of their loan books. 

Source: https://www.mas.gov.sg/-/media/mas-media-library/publications/financial-stability-review/2023/financial-stability-review-2023.pdf

 

Impact of U.S. Rate Cuts on SGD

A reduction in U.S. interest rates might weaken the U.S. Dollar (USD), which can lead to an appreciation of the SGD if other factors remain constant.

• Cheaper Imports: A stronger SGD makes imports more affordable, reducing the cost of inventory and raw materials for SMEs that rely on imported goods.
• Pressure on Exports: Conversely, an appreciating SGD can make Singapore's exports more expensive on the global market, potentially affecting SMEs involved in export-oriented industries.

However, there are a multitude of factors influencing foreign exchange rate movements. The USD might not weaken against the SGD due to its safe-haven status. Also, if global investors expect the US economy to outperform other major global economies, it could attract foreign capital inflows, thus strengthening the USD despite rate cuts. 

Hedging Strategies

In the interim period as central banks of other advanced economies make reactionary moves to the US Fed’s rate cuts, and global financial markets price in anticipated future rate cuts, the foreign exchange market will continue to be volatile. 

SMEs who are involved in import-export trade or have FX exposure from their business activities should consider hedging strategies to mitigate foreign exchange risks:

• Forward Contracts: Locking in exchange rates for future transactions.
• Currency Options: Gaining the right, but not the obligation, to exchange currency at a predetermined rate.

 

Secondary Effects of U.S. Rate Cuts on SMEs

Increased Disposable Income and Domestic Consumption

Lower interest rates in the U.S. can have a cascading effect on Singapore's economy:

• Reduced Home Loan Servicing Costs: Singapore's mortgage rates are pegged to local benchmarks like SORA, which in turn is influenced by market rates movements, especially U.S. interest rates. The SORA rate is expected to drop in tandem, but not necessarily relative to US interest rates.
• Higher Disposable Income: Reduced mortgage servicing payments increase household’s disposable income.
• Boost in Domestic Consumption: With more money to spend, consumers may increase spending in domestic-facing sectors such as retail and F&B.

Benefits to Retail and F&B Sectors

SMEs operating in retail and F&B stand to gain from heightened domestic consumption:

• Increased Sales Volume: More consumer spending can lead to higher revenue.
• Opportunity for Expansion: Favorable economic conditions may provide the impetus for business growth and expansion.

Potential Reduction in Rental Costs

Lower global interest rates can also affect property owners and landlords:

• Reduced Loan Servicing Costs for Landlords: Lower interest rates decrease the cost of servicing property loans.
• Less Pressure to Raise Rents: With decreased financial pressure on property loan servicing costs, landlords may be less inclined to increase rental rates, or at least slow down the rate of increase.
• Benefit to SMEs: Reduced or stabilized rental costs can alleviate one of the significant overhead expenses for SMEs, especially those operating in commercial and industrial spaces.

 

Strategic Considerations for SMEs

Financial Planning

SMEs should proactively engage in financial planning to take advantage of potential opportunities:

• Refinancing Existing Loans: Explore options to refinance existing loans at lower rates to reduce borrowing costs. If rates for new business loans drop below the rates of existing loans being serviced, consider applying for a fresh loan to redeem existing loans bearing higher rates. Take note of early redemption penalties on existing loans, if any.
• Negotiating with Suppliers: Use favorable exchange rates to negotiate better terms for imported goods for importers. 

 

Will SGD interest rates drop further?

Yes, we believe that SGD interest rates will drop in tandem, provided that the US Federal Open Market Committee carries out its planned subsequent rates cut in end 2024, and further cuts throughout 2025. 

We have plotted this line graph comparing the movements and correlation between U.S. Fed rates and Singapore’s 3-month SIBOR rate (now superseded by SORA rate). These figures are approximate average or end-of-year rates. 

The movement between U.S. and Singapore interest rates over the last 20 years shows a significant correlation, as illustrated in the graph. 

Singapore's interest rates have largely mirrored global trends and U.S. interest rate movement, but with a more gradual adjustment. The Monetary Authority of Singapore (MAS) manages monetary policy primarily through exchange rate adjustments, which influences local interest rates.

The graph above suggests that when US rates rise or fall, Singapore's interest rates often follow suit, albeit with some lag.

SME financing rates will likely see a gradual, but delayed drop only sometime in late Q4 of 2024, or even only from early 2025. We anticipate a 25 basis points drop in either Q4 2024 or early Q1 2025, and another 25 to 50 basis points reduction by end 2025. 

As mentioned earlier in this article, SME lending rates in Singapore are “stickier” and adjust much slower to market rate movements, especially in a falling interest rate environment. Rate movements are also on a much narrower band. 

We aggregated unsecured SME loan interest rates internally for loans originated within our platform. From the line graph below, we opined that SME interest rates have a weaker correlation to benchmark rates such as SIBOR (now SORA) and moves in a much narrower direction. 

The only divergence was back in 2020 during the peak of the Covid pandemic where interest rates fell to rock bottom, mainly due to government’s intervention and risk guarantees. 

Should I time the market? 

If you’re a SME business owner exploring financing to grow your business, do factor in the opportunity cost if you try to time the market and miss out on current opportunities. 

Based on the data discussed above in this article and our observations, we foresee SME loan interest rate to drop at most 25 basis points by the end of 2024, if at all. 

In perspective, for a $100K loan over a 5 year repayment period at 8.16% effective rate (average interest rate observed in 2023), monthly installment is about $2,035. A 0.25% reduction would equate to monthly installments of $2,023, just a $2 difference monthly.

Even if we extrapolate a larger loan quantum of say $500K at the same terms in the example above, the difference in monthly installments is just $60, insignificant compared to losing out on current opportunities in a fluid market. 

Time the market and take your time to monitor interest rate movements only if you do not have any urgent need for financing and there’s no better opportunity to deploy funds for better ROI at this moment. 

Summary 

U.S. Fed rates hikes or cuts have significant impacts on Singapore SMEs, both direct and indirect effects. As SMEs navigate this evolving landscape, strategic financial planning will be essential. Businesses should consider locking in favorable financing options now while exploring innovative ways to adapt to changing market conditions. By doing so, they can position themselves not just to survive but to thrive in a potentially volatile economic environment.