Cos may rein in capex as rate increases near
Households and businesses brace for increased borrowing costs
NEW DELHI/MUMBAI: Households and businesses alike are bracing for higher borrowing costs, with the Reserve Bank of India (RBI) expected to start raising interest rates in June. With corporate earnings already under pressure because of soaring input costs, the end of the era of cheap money is set to add to their challenges.
According to experts, the impending rate hikes combined with sharper input costs are expected to force companies to go slow on expansion plans to conserve cash. Companies, especially those with weaker balance sheets, are likely to redraw spending plans. Higher borrowing costs are also likely to crimp demand for homes, cars and appliances. “Higher interest rates always impact the overall economy negatively as it impacts capex plans and investments,” said Mitul Shah, head of research at Reliance Securities.
Moreover, companies also face a higher interest burden on existing debt, Shah added.
Mid-cap companies, which are facing the brunt of rising raw material prices, are among the most vulnerable to the monetary tightening cycle. Many of them had started showing signs of weakness in their ability to service debt in the December quarter. An analysis of 77 firms in the BSE Midcap index showed the interest coverage ratio, a measure of how easily a company can pay interest on its debt from earnings, declined sharply to 4.5 times at the end of the December quarter from 6.1 times at the end of the preceding quarter. Notably, it was also lower than the 4.7 times at the end of December 2020.
Borrowers will also have to brace for a faster hike in lending rates under the new external benchmark linked lending rate regime (EBLR) as RBI starts raising rates.
Under loan pricing based on external benchmarks, any change in the policy rate is passed on to the lending rates for new and existing borrowers immediately. 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 enjoyed the benefits of this loan pricing so far under a falling interest rate scenario, bankers warn that the hike in lending rates will be equally sharp. Many economists are pencilling in a policy rate hike of as much as 200 basis points this year, translating into an equivalent amount of lending rate hike, which economists believe will impact demand recovery.
“The issue is, if the repo rate is raised 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 disincentive for nascent demand recovery. In an increasing interest rate regime, transmission is therefore going to get difficult. Banks and RBI will find it difficult to tread this path,” said Soumya Kanti Ghosh, chief economist, SBI.
Telecom, realty, infrastructure, and a few more sectors with high debt and high working capital requirements may feel the heat, experts said.
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 when demand for corporate loans has started picking up after months of a lull.