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
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.