Big Hikes Hit The Small

Small and medium enterprises are the big­gest losers due to the sharp rise in in­ter­est rates on loans over the past 19 months

India Today - - INSIDE - By Dhi­raj Nayyar and Shravya Jain

Small and medium enterprises are the big­gest losers due to the sharp rise in in­ter­est rates on loans.

The Govern­ment is deeply di­vided on its strat­egy to tackle in­fla­tion. The Re­serve Bank of In­dia ( RBI) sig­nalled its hawk­ish stance clearly by rais­ing its key in­ter­est rate by 25 ba­sis points or 0.25 per cent on Oc­to­ber 25. This is the 13th time that RBI Gov­er­nor D. Sub­barao has hiked in­ter­est rates in the past 19 months in a bid to tackle per­sis­tent in­fla­tion. The fi­nance min­istry, how­ever, has a com­pletely dif­fer­ent view on where in­ter­est rates should go.

This view was ar­tic­u­lated by Chief Eco­nomic Ad­viser Kaushik Basu in Septem­ber when he told a tele­vi­sion chan­nel, “I be­lieve that (re­duc­tion of in­ter­est rates) is some­thing which ought to be con­sid­ered. When you have high in­fla­tion, the cen­tral bank’s stan­dard re­sponse is to in­crease the in­ter­est rate and my view is that we have done it. It had some im­pact, but not at the level which we ex­pected… We have to try a dif­fer­ent pol­icy, be­cause we don’t want to dam­age In­dia’s growth story.” Basu is tak­ing a leaf out of emerg­ing economies like Turkey and Brazil which have re­duced in­ter­est rates de­spite in­fla­tion to boost growth. This is be­cause in­fla­tion has been caused largely by sharp spikes in com­mod­ity prices like oil.

In­fla­tion in In­dia is driven by food items. In­ter­est rates have only a lim­ited ef­fect on this kind of in­fla­tion. But Sub­barao has a strong ally in C. Ran­gara­jan, chair­man of the Prime Min­is­ter’s Eco­nomic Ad­vi­sory Coun­cil. “The fact that in­fla­tion is trig­gered by food in­fla­tion or sup­ply side con­straints doesn’t mean that the mone­tary pol­icy doesn’t have a role to play,” said Ran­gara­jan at an eco­nomic ed­i­tors’ con­fer­ence in Delhi on Oc­to­ber 20.

In­dia’s growth has al­ready suf­fered a body blow. In­ter­est rates have gone up by 375 ba­sis points or 3.75 per cent in the last 19 months. There has been lit­tle dent on in­fla­tion. Af­ter a brief pe­riod in sin­gle dig­its, food in­fla­tion moved back into dou­ble dig­its for the week end­ing Oc­to­ber 8. The whole­sale price in­dex con­tin­ues to hover close to 10 per cent even as growth has fallen sharply from 9.4 per cent in the quar­ter be­tween Jan­uary and March 2010 to 7.7 per cent in the quar­ter April to June 2011. Now, RBI has re­vised its growth out­look for the fis­cal year end­ing March 2012 to 7.6 per cent from its ear­lier 8 per cent.

Says Saugata Bhat­tacharya, chief econ­o­mist at Axis Bank, “A slow­down is def­i­nitely vis­i­ble. Of par­tic­u­lar con­cern is the slow­down in in­vest­ment. This could cre­ate sup­ply side prob­lems for the econ­omy in the medium term.” Ma­hesh Vyas, man­ag­ing di­rec­tor and CEO of the Cen­tre for Mon­i­tor­ing the In­dian Econ­omy, makes a more nu­anced ar­gu­ment. “High in­ter­est rates are im­pact­ing the prof­its of smaller com­pa­nies that are well geared (ex­posed to debt). How­ever, a larger chunk of com­pa­nies are cash rich, low on debt and there­fore not af­fected.” He adds, “And since the larger com­pa­nies have a much larger share of to­tal cor­po­rate sec­tor profit, the sec­tor as a whole is not show­ing much stress.”

The stress on small and medium enterprises ( SME) which rely on bank fi­nance is se­ri­ous. Says Ro­hit Bha­tia, man­ag­ing di­rec­tor of Onas­sis Auto, a medium-sized auto com­po­nents man­u­fac­turer based in Mane­sar, Haryana, “Our profit mar­gin has been to­tally squeezed. We any­way keep only a 57 per cent mar­gin. But now with cost of in­put ma­te­ri­als in­creas­ing and the rate of in­ter­est also ris­ing, we have a prob­lem from both sides.” Onas­sis Auto, which ex­pects to clock up sales of Rs 78 crore this fis­cal year, runs two fac­to­ries: one that sup­plies compo-

nents for the do­mes­tic mar­ket and one that caters to the over­seas mar­ket. Bha­tia says the sit­u­a­tion is re­ally bad on the do­mes­tic front. The plant that runs his in­ter­na­tional op­er­a­tions is sup­port­ing do­mes­tic op­er­a­tions. “If we didn’t have exports, we would have long shut down,” he says. Un­cer­tain about the fu­ture, Bha­tia plans to cut down on do­mes­tic op­er­a­tions and switch en­tirely to exports in one or two years. “If loans were cheaper I’d have taken one. But I don’t want to as there is uncer­tainty about how high the rates will go,” he says.

Ramk­is­han Agrawal, chair­man of Ut­tar Pradesh-based Basera Builders, a medium-sized real es­tate com­pany, is deeply wor­ried about the com­bined ef­fect of high in­fla­tion and high in­ter­est rates. High in­ter­est rates on home loans have made cus­tomers wary of tak­ing them. As a re­sult, flats are go­ing un­sold, mak­ing it dif­fi­cult for Agrawal to re­pay loans made costlier by the fre­quent in­ter­est rate hikes. Says Agrawal, “The num­ber of home buy­ers has dwin­dled con­sid­er­ably. Houses have been built but no one is buy­ing.” His com­pany also took loans to fi­nance con­struc­tion in the pe­riod be­fore March 2010 when rates were still rea­son­ably low. Now, the cost of ser­vic­ing that loan has gone up. “Who’d have thought the rates would go up nearly 2 per cent in lit­tle over a year,” rues Agrawal. Some of the com­pany’s hous­ing projects have been put on hold till the sit­u­a­tion eases.

A study con­ducted by rat­ing agency CRISIL in Jan­uary 2011 sug­gests that SMES have been se­ri­ously im­pacted by ris­ing in­ter­est rates. The study es­ti­mated that ev­ery 1 per cent in­crease in in­ter­est led to a 14 per cent de­cline in prof­its. No re­lief for

SMES seems likely from the RBI un­til at least the end of fi­nan­cial year 201112, when the cen­tral bank ex­pects in­fla­tion to come down to 7 per cent.

There is also the additional con­cern of ris­ing lev­els of non-per­form­ing as­sets for banks and fi­nan­cial in­sti­tu­tions as SMES strug­gle to re­pay loans. In a re­lease in Septem­ber, CRISIL found that the in­crease in in­ter­est rates would ad­versely af­fect the as­set qual­ity and prof­itabil­ity of banks. Ac­cord­ing to the rat­ing agency, banks’ gross non-per­form­ing as­sets are ex­pected to rise to about 3 per cent by March 2012, com­pared with 2.3 per cent a year ago. “The pres­sure on as­set qual­ity is ex­pected to arise pri­mar­ily be­cause of the weak­en­ing debt ser­vic­ing abil­ity of the cor­po­rate sec­tor, es­pe­cially the SME seg­ment,” it said in a state­ment in Septem­ber. Says a banker on con­di­tion of anonymity, “This could even­tu­ally build up into a se­ri­ous threat to the sta­bil­ity of the fi­nan­cial sys­tem.” The RBI takes great pride in its sound reg­u­la­tion of the fi­nan­cial sys­tem. It will be ironic if its in­ter­est rate poli­cies desta­bilise it.

CHANDRADEEP Ku­mar/www.in­di­a­to­day­im­ages.com

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