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8.25.99  
Who's Afraid of a Quarter-Point Rate Hike?
The Fed's latest move to quell inflation will pinch those who've overindulged on credit

U.S. small businesses have revelled in this economic expansion. Given booming demand, low inflation, and cheap credit, you couldn't ask for better business conditions. Now, is Alan Greenspan about to spoil the party?

The U.S. Federal Reserve's quarter-point increase in the fed funds target rate Tuesday to 5.25% was the second this summer. The U.S. central bank is clearly back on the inflation vigil — though it indicated Tuesday that this increase should suffice for a while.

In the grand scheme, quelling inflation is certainly good for small business — even if it does keep the brakes on U.S. economic growth, which has already slowed to an annualized 2.3% in the second quarter, down from 4.3% in the first. "We like the low-inflation environment," says William Dunkelberg, chief economist for the National Federation of Independent Business. "We've never had such good conditions." The high-inflation 1970s "were horrible" for small business, he recalls.

The latest NFIB economic survey did signal some inflationary tendencies — a net 8% of those surveyed raised average selling prices in July (the net percentage subtracts those cutting prices from those raising them). That's miniscule compared to the 1970s, when a net 70% or more raised prices. Still, the percentage has risen steadily, from 1% in January — an "unfriendly trend," Dunkelberg wrote in a report on the data.

More immediately, small businesses with variable-rate loans will feel a 0.25-point to 0.40-point pinch — or more if their loans haven't yet been adjusted to reflect the June fed-funds increase. "The net effect to small business will be mildly negative," says Warren Heller, director of research at Veribanc, Inc., a Wakefield (Mass.) bank rating and research firm.

NFIB data suggests as many as 38% of small businesses would feel the increase in rates directly — that's the percentage that reported borrowing last month. The incidence of borrowing is actually historically low, says the NFIB report. That may sound surprising, given that average short-term borrowing rates were only 8.8% in July, down from 9.1% in May. (For comparison, short-term small-biz borrowing rates peaked since the 1990-91 recession at 10.6% in June, 1995.) But cash flow has been so good, Dunkelberg says, that many companies didn't need to take on debt.

So who should really be worried about tighter credit policy? Anyone who has overindulged on easy money, say other small-business financial analysts. For a healthy company that's taken advantage of this boom to clean up its balance sheet and build a cash stockpile, "these changes have minimal effects," says Charles Green, Atlanta-based vice president of the Bank of Commerce, which is headquartered in San Diego. "But for someone who's marginal, even a slight increase can send you down the road to problems."

The easy terms of the last few years have emboldened both lenders and borrowers. Credit-card companies and banks have "discovered" small businesses and have been competing fiercely for their business, which typically generates high fees. "I'm always as wary of times that are too good as times that are terrible," says Green. "Too often banks get into a follow-the-leader strategy. One gets very aggressive with lending and others follow. When that happens, borrowers think they're more creditworthy than they are. Lower rates fuel this."

There may be more small businesses that can fund investment from cash flow, Green says, but those that need to own real property — motels and some retailers, for example — have to borrow long-term and are vulnerable to rising rates if their finances aren't in order.

High-tech and service companies, which typically have trouble getting bank loans, may feel insulated from higher interest rates because they're still relying on friends, family and credit cards for financing. That may be somewhat illusory. Many people who are funding their businesses on plastic simply pay the minimum each month, so they may not pay attention if their rates rise. But, with interest rates higher, it'll take them that much longer to pay down their outstanding balance. "Everyone needs to do a little soul-searching, if they don't have a cash reserve," Green says. That's good advice to follow — while the going is still good.


By Julia Lichtblau in New York
julia_lichtblau@businessweek.com

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