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Rate hike: Impact on India Inc.

Jun 9, 2006

The RBI’s initiative to hike the benchmark inter-bank borrowing and lending rates (repo and reverse repo) by 25 basis points, although vetted as ‘out of the blue’ by corporates, is well in line with the central bank’s mandate of keeping inflationary concerns in check. This is well articulated by the fact that the bank took this measure at a time when it is needed most. Although one might argue that the RBI is trying to fall in line with its counterparts globally with the ’25 basis point hike’ ritual, it is also to be noted that this comes at a time when inflationary concerns in the domestic economy are calling for one. This is the reason, instead of raising the benchmark rates in the annual monetary policy, the central bank opted for an interim rate hike, in the aftermath of rise in oil prices and hardening CPI (consumer price index). Impact on the banking sector…
While the PSU banks have divorced their views on liquidity in the banking system from their private sector players, the fact that stands unchallenged is that the interest rate scenario is no longer ‘stable’ in the medium term. Banks have opined that rate hikes on advance books is not pertinent given that:

  • Liquidity position is currently comfortable

  • Rate hike is not warranted on the deposit side, and

  • Rate hikes have already been factored in by most banks in their PLRs

However, banks that have a substantial proportion of their advance portfolio in the sub-PLR category (home loans and agri loans) are most likely to feel the pinch and will, thus, necessarily have to take a call on their lending rates. Reluctance on the part of banks to pass on the higher funding costs to their customers will also take a toll on their net interest margins (NIMs), which are already under pressure. This coupled with lower credit offtake from corporate and retail customers alike may see the banking sector players post lower topline growth in the coming fiscals.

Impact on manufacturing and other service sectors…
Manufacturing sectors like metals, auto, capital goods, textile and pharma that have acquired considerable debt in the recent past will see their interest costs rising in the current scenario. This might have an impact on their net margins and erode their bottomline. Service sectors like telecom, hospitality and retailing that are highly leveraged will also face the brunt. This again warrants a caveat that the huge capex plans earmarked by corporates in the past couple of months may get deffered, depending upon their debt servicing ability.

Our outlook…
While our outlook on interest rates, as we have reiterated time and again in the past, remains with an upward bias, we would also like to assure investors that most of it has been factored in our projections for the respective sectors. Also, in a broader perspective, the rate hike will prove to be benign for the health of the domestic economy in the longer term. Investors need to keep in mind that the economic growth and corporate profits may get moderated in the near term and to that extent they need to moderate their return expectations. Nevertheless, the RBI’s accommodative monetary policy is certainly well timed!

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