New Delhi/Mumbai With the Reserve Bank of India (RBI) expected to start raising interest rates in June, families and businesses alike are gearing up for higher borrowing costs. With corporate earnings already under pressure due to rising costs, the end of the cheap money era is set to add to their challenges.
According to experts, sharp rise in prices as well as sharp input costs are expected to force companies to slow down expansion plans to save cash. Companies, especially those with weak balance sheets, are likely to revise spending plans. Higher borrowing costs are also likely to reduce demand for homes, cars and appliances. Mitul Shah, Head of Research, Reliance Securities said, “High interest rates always negatively impact the overall economy as it affects capex schemes and investments.” Besides, companies also face higher interest burden on existing loans, Shah said.
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Mid-cap companies, bearing the brunt of rising raw material prices, are the most vulnerable to the cycle of monetary crunch. Many of them started showing signs of weakness in their ability to repay their debt in the December quarter. An analysis of 77 firms in the BSE Midcap index shows that the interest coverage ratio, the ease with which a company can pay interest on its debt from earnings, sharply declined to 4.5 times at the end of the December quarter. was 6.1 times. of the last quarter. Notably, it was less than 4.7x at the end of December 2020.
Borrowers under the new External Benchmark Linked Lending Rate Regime (EBLR) will also have to be prepared for a sharp hike in lending rates as the RBI starts raising rates.
Under loan pricing based on external benchmarks, any change in the policy rate is immediately passed on to lending rates to new and existing borrowers. Banks are not allowed to adjust their spreads for existing borrowers for three years in the absence of any significant credit event. While borrowers have so far taken advantage of this loan pricing in a falling interest rate scenario, bankers have warned that the rise in lending rates will be equally sharp. Many economists are projecting a policy rate hike of 200 basis points this year, translating into an amount equivalent to an increase in the lending rate, which economists believe will hit demand recovery.
“The point is that if the repo rate is hiked by X basis points, the entire lending rate will go up by that amount, to the extent that other things remain the same. This will act as a deterrent for nascent demand recovery. So in a rising interest rate regime, transmission is going to be difficult. “Banks and RBI will find it difficult to follow this path,” said Soumya Kanti Ghosh, chief economist at State Bank of India.
Experts said telecom, realty, infrastructure, and a few more sectors may feel the heat with higher debt and higher working capital requirements.
That said, banks have started hiking rates for existing corporate and retail loan customers who have taken loans under the marginal cost of funds lending rate. This comes as the demand for corporate loans has started picking up after months of sluggishness.
According to CareAge Ratings (formerly CARE Ratings), outstanding bank credit grew 9.6% as of March 25 from a year ago, driven by retail lending, increase in working capital requirements and capital raising by large firms from the banking system rather than . Counterpart Market. However, an increase in interest rates may reduce the demand for loans.
The upcoming 5G spectrum auctions and heavy spending on capital expenditure investments may be troublesome for telcos. Experts say rising interest rates could be a cause for concern for telcos, which have high net debt and are struggling to show profits.
Higher rates may hurt infrastructure companies. Metal companies committed to capacity expansion and capex may also face challenges. “However, many metal companies using a favorable commodity cycle have significantly improved their balance sheets,” Shah said.
Rising interest rates will further dilute the prospects of the auto sector.
“Higher rates have had an adverse impact on the auto sector as it increases the total cost of vehicle ownership. Sreekumar Krishnamurthy, Vice President and Co-Group Head, Corporate Ratings, ICRA Ltd said, any further hike in interest rates will impact consumer spending decisions.
Shayan Ghosh in Mumbai; and Gulveen Aulakh and Alisha Sachdev in New Delhi contributed to the story.