RBI GETS RATE RESPITE, BUT COST OF FUNDS FOR FIRMS TO SOFTEN

Interest rates in the economy could be nearing the bottom as aggressive cuts in corporate taxes by the Centre have obviated the need for further monetary policy support, analysts have said.

But the borrowing cost for corporates can still come down owing to an improved balance sheet and rating upgrades. Indeed, rating agency Moody’s commented that the “move is credit positive for companies because it will enable them to generate higher post-tax incomes”.

Bond yields jumped 15 basis points (bps) fearing absence of rate support and increased supply, but economists say the Reserve Bank of India (RBI) will again have to step in to manage yields through secondary bond market purchases under its open market operations (OMO). This will be done mainly to help the government borrow cheap, which has become imperative after a ~1.45 trillion hole in the coffers in revenue foregone through tax cuts, economists and bond dealers say.

“We expect the RBI to frontload its OMO purchases to contain yields with purchases starting as early as October,” said A Prasanna, chief economist of ICICI Securities Primary Dealership Ltd.

But there is a near consensus that notwithstanding Reserve Bank of India (RBI) governor Shaktikanta Das talking about more room for cuts, that space has shrunk considerably after Friday’s tax cuts. Not only it helps the RBI go slow on monetary policy support, the tax cuts could give rise to inflation in the medium term. So, even those economists who were expecting the central bank to cut 40 bps on October 4 policy, and then another 25 bps later in the year due to sub-5 per cent growth numbers are in the process of revising their estimates. Most expect the repo rate to bottom out at 5 per cent and stay there for a long time.

Standard Charted economist Anubhuti Sahay said even as the RBI could be cutting the policy rate by 25 bps on October 4 policy, the market expectation is that larger tax cuts “may scale back policy rate cut expectations after this announcement”.

According to Gaurav Kapur, chief economist of Indusind Bank, the fiscal stimulus “would also help reduce the pressure on the monetary policy to do the heavy lifting on countering the slowdown through lower interest rates”.

Since February, the RBI has lowered policy repo rate by 110 bps to 5.40 per cent. The monetary policy stance in the last policy was “accommodative”, indicating the RBI was open to more rate cuts. Even as the stance would remain the same, the chances of it reverting back to “neutral” increases. The sharp rise in bond yields soon after the tax rate cuts reflects the market’s displeasure with that reality. The prospect of increased supply in bond yields at closer to the rate-ending cycle has fatigued the bond market. And they are pushing the bond yields up, which in turn has pulled up corporate bond yields too.

So, the 10-year ‘AAA’rated bond yields shot up to 7.94 per cent on Friday, from 7.79 per cent on Thursday, 15 bps jump in line with the 10-year gsec. Interestingly, the one-year AAA bond rose only 6 bps to 6.79 per cent, indicating the system liquidity is comfortable and the bond market really don’t have a problem giving short-term money to the companies given their increased cash flow visibility.

The corporate reality

Corporate executives say the rise in yields don’t bother them as much as the investors in these bonds. After the tax cuts, cost of funds for India’s struggling corporate sector will likely ease up with increased profitability and healthier credit ratings. “If the tax is less, the bottomline improves, which makes the lenders happy and comfortable lending to the companies. Investment push will create more jobs and demand should increase, which should improve the topline too after sometime,” said Prabal Banerjee, group finance director at Bajaj Group.

Borrowing cost is mainly a function of availability of liquidity and the future cash flow of a company. According to Subba Rao, the tax breaks improve the profitability straightaway for the companies, which should translate into better cash flow, “unless the companies waste it away by lowering prices and give steep discounts for the sake of competition”.

“The tax cuts help the companies for a year or two, but their conduct in this period will determine if this euphoria and talk of animal spirits is temporary or permanent.”

Experts say there are enough examples of how tax breaks need not be the panacea for a long term recovery. In the United States itself, tax breaks immediately lead to boost in company valuations and profitability, but a year down the line, the same companies are back to square one and struggling with the same set of problems that were there before getting the tax breaks.

Ashutosh Khajuria, executive director at Federal Bank, said the government and the RBI have done what they could for the corporate sector, and to revive demand. Now it is left for the companies to take things forward as their tax rates become aligned with others in the region and the world.

In any case, the RBI’S rate cuts were not bringing down cost of borrowing for the corporate sector substantially, as the 10-year G-sec yields were at 7.3 per cent in March. This dropped to 6.52 per cent in early September, but spreads above G -secs remained high, because of stressed balance sheets. Retail loan customers, though, would benefit from a rapid transmission because of a repolinked loan.