Implications of interest rates on startups

Interest rates say a lot about what it's like starting a business in an economy and what other startups are like in an economy.
Interest rate is the amount charged  by a lender to a borrower expressed as a percentage of the amount lent. Typically it is an annual charge. For the purpose of this article interest rate refers the average interest rate offered by financial institutions to  investors in an economy.

It tells you about Inflation

This one is easy. The rate of inflation tells you how much of the purchasing power of a currency is lost annually. For banks to earn a profit from the money they lend, the interest they charge must be higher than the value lost to inflation. So while the Central Bank typically uses interest rates to control inflation, even without central bank involvement, inflation sets a floor below which commercial banks are not likely to lend money.

It tells you how high the average Return On Investment is

In many economies  commercial banks are restricted in where they are allowed to make money, to oversimplify, they are only allowed to make money off fees and interest from loans. So if banks in an economy are thriving with an interest rate of say 20%, that should mean that the average return on investment is higher than 20%. Globally, a ROI of 20% is pretty good.

It tells you how big a startup typically is in an economy

High returns are more common in small investments. Its easy to double(100% return) a dollar, doubling 100$ is harder but still easier than 1000$. An economy with abnormally high returns likely has few large investment opportunities. High interest rates discourage large borrowing and without access to cheap financing more startups are likely to start really small and stay small for longer.

It tells you how hard or easy it is for a startup to survive

If a business borrows at 20%, to stay in business it has to have margins exceeding 20% or more funding from investors, otherwise it will default on its interest payments. In other words, interest rates set how profitable a business should be to survive. With low enough interest rates a startup can survive with 5% returns while a startup in Uganda struggles to survive with 20% ROI because it has to service a 25% loan.

It tells you how competitive an economy is

Everything else the same, an economy where interests rates are 20% will not be able to sell things as cheaply as an economy where interest rates are 3%. If a Ugandan wants to start a dish soap business with a loan, she might have to deal with servicing 20% interest payments on that loan, to stay in business she has to charge at least 20% margins. Meanwhile, she might have to compete with foreign companies that can stay solvent with 5% operating profits.

The implications of interest rates go far beyond what I can cover in this article. Let it suffice for now that interest rates have a say in just about everything you pay for. In many ways the interest rates of an economy tell you how how much confidence there is in the future of that economy. The higher the interest rates the lower the confidence. After all, interest is the price you pay to borrow from your future.

Disclaimer: I'm not an economist, I don't have a background in finance, I'm an engineer who likes figuring things out. I especially love systems, things that connect and interact. 
Image credit: Pictures of money