Managing Your Farm as Interest Rates Fall

Tuesday, November 19, 2024

‘Reduced Borrowing Costs & Improved Cash Flow Could Offer Opportunities’

By Mary Loggan

The Bank of Canada lowered its key interest rate to 4.25 per cent on Sept. 4, making it the third consecutive cut in a row for Canadians.

These reductions started in June when the bank slashed its benchmark interest rate for the first time in four years. With another announcement planned for Oct. 23, many experts predict even lower rates to come.

Most Canadians experience lower interest rates through mortgages and various forms of consumer debt, including credit cards, personal loans, and auto loans.

However, with the current economic climate, low interest rates could offer a silver lining for farmers looking to invest and expand their operations.

With borrowing costs at lower levels, producers could access capital more easily, allowing for investments in equipment, technology, and sustainable practices.

Better Farming recently spoke with Graeme Crosbie, senior economist at Farm Credit Canada, to discuss what lower interest rates could mean for Ontario producers.

The benefits for farmers

According to Crosbie, “The obvious immediate benefit is that anyone with a variable-rate loan will see lower payments and – all else equal – improved cash flow.”

Of course, “Those with a fixed-rate loan won’t benefit until their current term is up for renewal.”

Reduced borrowing costs and improved cash flow could offer opportunities for producers to expand their farms.

Lower rates can make it more affordable for farmers to invest in their operations. This could encourage producers to take on new projects, expand their land base, or upgrade technology, which may also lead to improved productivity and efficiency.

Crosbie states, “Regardless of whether a producer wants to take out a variable or fixed-rate loan, they will benefit when their current term comes up for renewal (or if they are taking out a new loan) as they will see more attractive rates today than would have been the case just a few months ago.”

Potential negative impacts

While reduced interest rates could provide opportunities, Crosbie stresses the need for sound management to navigate potential risks associated with increased investment and market fluctuations.

He points out, “Central banks typically begin lowering interest rates to provide some stimulus when there are economic storm clouds on the horizon.

“This is certainly the case at the moment. Unemployment in Canada has trended higher since early 2023 and GDP growth has been positive but low (and is forecast to remain so for the next year at least).

“So, while reduced rates are generally cash-flow positive for a farmer, it likely indicates the economy is losing steam.”

Crosbie says this is important when making management decisions; even though rates continue to drop, farmers must always consider how quickly the economy can change.

“A worse economy can lower demand for end-products, including those produced at the farm. Commodity prices could move lower alongside uncertain and weaker economic conditions.

“We’ve seen that recently with feeder cattle future prices, which fell in August in large part because of investor concerns the U.S. economy was starting to show signs of weakness.”

Crosbie also warns interest rates can influence currency values. If Canada’s rates remain low relative to other countries, the Canadian dollar might weaken, making our ag exports more competitive in the global market.

Longer-term effects

Crosbie explains that “lower interest rates can change the calculation of the return on long-term investments through something called the discounted payback period.

“Decreased rates result in future cash flows that appear more valuable – meaning you recover your initial investment more quickly.”

However, he warns that while decreased rates can facilitate access to credit, they might also encourage farmers to take on higher debt.

If not managed wisely, this could lead to financial stress if market conditions change, or interest rates rise in the future.

Nevertheless, Crosbie says, “In the long run, producers that can make these targeted investments today should benefit from higher productivity and/or on-farm efficiencies.”

Planning for the future

“Every operation is unique,” Crosbie says. “Communication with your lender is incredibly important, as there are so many different factors to consider when choosing whether or not to make an investment, and what type of loan product makes the most sense for your operation.”

He recommends that farmers evaluate the risks and benefits of these decisions and what they could mean if the economy were to change.

“This includes, but is not limited to, the timing of capital investments (loans being paid off, when new investments will be required); product features, including prepayment limits and fees; cash flow and structure of existing debt, including existing floating debt exposure; and one’s own risk tolerance.

“Scenario analysis can help operators understand their risk exposure within different economic environments,” he says.

While lower interest rates present opportunities, farmers should remain vigilant about potential long-term implications, such as rising debt levels and market volatility as the economy eventually adjusts.

Balancing the advantages of cheaper financing with financial management is critical. BF