NEW DELHI/MUMBAI : Households and businesses brace for higher borrowing costs as the Reserve Bank of India (RBI) is expected to start raising interest rates in June. With corporate profits already under pressure due to soaring input costs, the end of the era of cheap money is expected to add to their challenges.
Experts say impending rate hikes combined with rising input costs are likely to force companies to slow down their expansion plans to conserve cash. Companies, especially those with weaker balance sheets, are likely to revise their spending plans. Higher borrowing costs are also likely to dampen demand for homes, cars and appliances. “Higher interest rates always have a negative impact on the overall economy as they impact investment 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 bear the full brunt of rising commodity prices, are among the most vulnerable to the monetary tightening cycle. Many of them had started to show signs of weakness in their ability to service debt in the December quarter. An analysis of 77 companies in the BSE Midcap Index showed that the interest coverage ratio, a measure of how easily a company can pay interest on its debt from earnings, fell sharply to 4.5 times at the end of the December quarter, compared to 6.1 times at the end. of the previous quarter. Notably, it was also lower than the 4.7 times at the end of December 2020.
Borrowers will also need to prepare for a faster rise in lending rates under the new External Benchmark Linked Lending Rate (EBLR) scheme as the RBI begins to raise rates.
Under loan pricing based on external benchmarks, any change in the policy rate is immediately reflected in lending rates for new and existing borrowers. Banks are not allowed to adjust their spreads for existing borrowers for three years absent any significant credit event. While borrowers have so far reaped the benefits of this loan pricing in a lower interest rate scenario, bankers are warning that the rise in lending rates will be just as steep. Many economists envisage a hike in policy rates of up to 200 basis points this year, translating into an equivalent increase in lending rates, which economists say will have an impact on the recovery in demand.
“The problem is that if the repo rate is increased by X basis points, the total lending rate will increase by that amount, as long as other things stay the same. This will have a chilling effect on the nascent recovery. In a rising interest rate regime, transmission will therefore become difficult. Banks and RBI will find it difficult to go down this path,” said Soumya Kanti Ghosh, Chief Economist, State Bank of India.
Telecoms, real estate, infrastructure and a few other sectors with high debt and high working capital needs could feel the heat, experts said.
That said, banks have begun raising rates for existing business and personal loan customers who have taken out loans below the marginal cost of funds lending rate. It comes as demand for business loans has started to pick up after months of lull.
According to CareEdge Ratings (formerly Care Ratings), outstanding bank credit rose 9.6% as of March 25 from a year earlier, driven by retail lending, an increase in working capital requirements and the raising capital by large companies from the banking system instead of the bond market. However, demand for loans is expected to fall if rates rise.
Telecom companies, which are expected to spend heavily on upcoming 5G spectrum auctions and capital investments, could feel the pinch. Rising interest rates could worry telecom operators, which have high net debt and struggle to show profitability, experts said.
Higher rates could harm companies in the infrastructure sector. Metal companies that are committed to increasing their capacities and investments may also face challenges. “However, many metallurgical companies using the favorable commodity cycle have significantly reduced their balance sheets,” Shah said.
Rising interest rates further cloud the outlook for the automotive sector.
“Higher rates have had a negative impact on the automotive sector as they lead to an increase in the total cost of ownership of a vehicle. Any sharp tightening in interest rates will affect consumer spending decisions,” said Srikumar Krishnamurthy, Vice President and Group Co-Head, Corporate Ratings, ICRA Ltd.
Shayan Ghosh in Bombay; and Gulveen Aulakh and Alisha Sachdev in New Delhi contributed to the story.