RBI’s interest rate hike to hit small businesses more

MOST LOANS TAKEN BY SMALL BORROWERS ARE LINKED TO AN EXTERNAL BENCHMARK AND REPO RATE

With most of their loans linked to an external benchmark, small businesses will feel the bite of rising borrowing costs almost immediately as the Reserve Bank of India’s (RBI’s) surprise 40-basis points rate hike ripples through the banking system, experts said.

A large chunk of loans taken by small borrowers are linked to an external benchmark and, more often than not, to the repo rate. A 40-basis points (bps) hike would raise their borrowing cost by an equivalent amount. For larger firms, lending rates are primarily linked to the marginal cost of funds based lending rate (MCLR), an internal benchmark where transmission is slower than external benchmarks like the repo and treasury bills.

As of December, 70.9% of all loans to large industries were linked to MCLR and 20.4% to external benchmarks. For small businesses, loans linked to MCLR were at 24.2% of their aggregate loans, while 69.2% of loans were on external benchmarks, showed data from the RBI. The monetary policy committee, through its 40 bps repo rate hike on May 4, reversed the cut effected during the pandemic in May 2020.

“Companies that are doing very well and seeing good demand will continue investing, but sectors seeing subdued demand will have no reason to invest when the capital cost is high,” said Madan Sabnavis, chief economist, Bank of Baroda.

Demand for cement, a key indicator of economic activity, when plotted against changes in RBI repo rate, showed divergent correlation over the years, according to data analyzed by Nirmal Bang Institutional Equities. For instance, while the repo rate was lowered by 40 bps in 2020-21, demand for cement declined by 1%. In contrast, when the rate was cut by 25 bps in FY18, cement demand rose 7.1%.

That said, the idea of a rate hike is to rein in demand and, in the process, control inflationary pressures in the economy. While fiscal policy controls the supply side, the monetary policy helps correct excess demand.

Experts said since the economy is already experiencing high inflation, consumption will remain subdued, and people will spend more on necessities. Therefore, the capacity utilization, which has been somewhat improving, will now slow, hampering future investments.

Analysts pointed out that the relationship between loan growth and policy rates has not been quite strong, with a lot dependent on the nature of growth and the phase of economic growth.