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Who’s Ready For A Cocktail Of Threats?

We, the world that is, have been spoilt by nearly eight years of low interest rates. It is sometimes easy to forget that interest rates not only go down or stay the same, as they have done for some considerable time, but they can go up too.

An interest-rate rise is one of the many ingredients in the cocktail of economic risks that the UK Chancellor, George Osborne, has alluded to for the British economy. But what applies to the UK economy could also apply to other economies around the world.

Good health

In itself, a rise in interest rates should not be seen as threatening. An interest-rate rise could suggest that an economy is in good health.

After all, interest-rate rises tend to follow the business cycle. As an economy starts to show signs of improvement, interest rates tend to go up. They eventually peak at roughly the same time that the business cycle reaches its highest point.

The time to worry is when interest rates are being cut because it could mean that the economy is showing signs of slowing.

Promising signs

Currently, there are promising signs that some of the largest economies in the world are expected to grow, even though the growth rate might only be anaemic.

The US is expected to grow around 2%, while China could grow at between 6% and 7%. Japan and Germany, which are the third and fourth-biggest economies in the world, could grow around 1.6%. The UK and France could grow at 2% and 1%, respectively.

Whilst there are encouraging signs that the global economy is gradually returning to health, not all businesses, or in some instances, economies are prepared for rises in interest rates.

Roof repairs

These include heavily-indebted companies and those economies that are still burdened by excessive borrowings. It is metaphorically known as “Failing to fixing the roof when the sun is shining”.

Many companies, many consumers and many economies took on inexpensive debt, when money was cheap. However, as the old saying goes: “If you owe money, you either have to repay it or face bankruptcy.

Creditors could therefore be vulnerable. For instance, last year, around 100 global companies defaulted on their debts. It was the second-biggest default count for more than a decade.

Debt default

The default tally was exceeded only by the financial crisis, when over 200 companies failed to repay their loans in 2009.

But unlike the financial crisis that was triggered by falling property prices in the US, the damage this time has been initiated by falling commodity prices.

Many resources companies have struggled under low oil and commodity prices. The default rate for metals and mining companies climbed to 15% this month compared with 11% last month.

But it is not only commodities companies that have found conditions challenging. Some countries have struggled too. Puerto Rico, which has an annual economic output of about US$103 billion, is struggling under debts of about US$70 billion. It has defaulted on its loans twice in five month.

Far reaching

Loan defaults could have far-reaching consequences.

It could affect banks which are generally the main source of borrowing. It could also impact insurers and bond investors, who have benefitted disproportionately over the last eight years from falling interest rates.

Between 2006 and 2014, bond investors could have reaped returns of more than 6% on investments that are normally perceived to be both boring and safe. However, those heady days of above-average returns could be over.

For every 1% rise in interest rates, the price of 10-year Treasuries could potentially fall by 9%.

Debt free

Companies that have no debt can’t go bankrupt. The same goes for sovereign states and consumers. The key to successful investing, therefore, is to look to those that are either cash rich or those that are able to manage their debts adequately.

In Singapore, there are many companies with little or no debt. Within the Straits Times Index (SGX: ^STI), they include Genting Singapore (SGX: G13), SIA Engineering (SGX: S59), Singapore Airlines (SGX: C6L) and Singapore Exchange (SGX: S68).

The financially fittest will survive. They might even prosper.

A version of this article first appeared in the Independent on Sunday.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Director David Kuo doesn’t own shares in any companies mentioned.