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Changing times - Views on News from Equitymaster
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  • Nov 16, 2004

    Changing times

    Over the last 3-4 years, India Inc. has been on a path of restructuring, realizing the importance of improving efficiencies. Over the years Indian companies have been able to significantly restructure their debt costs and this has been a key component of their overall restructuring drive. In the last 3-4 years, internal as well as external factors have gone in favour of Indian companies and this has led to significant savings in the form of reduced interest expenses. The case in point being the consistent fall of interest rates both domestically as well as internationally.

    In the backdrop of ever-falling interest rates, Indian companies effectively managed to reduce their interest outgo in the last few years. Just to put things in perspective, interest rates (for top corporates) fell from a high of 12% in FY96 to nearly 6% in FY04. Due to falling interest rates, the prime lending rates (PLR) were also reduced by banks, which came down from a high of 16.5% in FY96 to around 11% in FY04. India Inc. was benefited not only from the domestic fall in interest rates but also from international decline in the same. Interest rates in the US fell from a high of 5% in March 2001 to lows of around 1% in FY04 (albeit they have risen in the recent past).

    This movement in international interest rates is of particular advantage to the leaders of India Inc. as they are in a position to reap the benefits of external commercial borrowings (ECB's). Companies can borrow loans in the international markets at rates lower than the prevailing domestic interest rates. However, it must be noted here that, firstly, not many corporates have access to ECB's. Secondly, this advantage is capped to a certain limit due to various regulatory issues and policies.

    However, let us now come back to the present scenario. Domestic as well as international interest rates are on the rise. While the RBI has not raised the indicative bank rate in the recent monetary policy, the indication was that if inflationary pressures do not ease, the RBI would not shy away from raising interest rates. Domestic banks are already on the verge of raising interest rates. The US Fed has already raised the Fed rate to 2% from its low of 1%. All these moves signify the fact that interest rates may have bottomed out and that India Inc. will have to contend with higher interest rates going forward.

    Investors on their part have to realise that the improvement in profitability seen by Indian companies in the last few years due to falling interest rates would no longer be seen. Improvement in operating efficiencies would now be the key driver of profitability apart from higher growth in demand. Investors need to concentrate now squarely on how much further Indian companies can restructure their operations as well as grow their markets (i.e. demand).

    As India Inc is on an expansion spree, one needs to keep in mind the fact that interest expenses would rise from here on (due to higher debt being infused to grow capacity). From here on, the key question now is whether Indian companies would be able to pass on higher costs (both input as well as financing costs) to its consumers. That apart, investors also need to critically study the expansion plans of companies. After all no investor wants to be caught on the wrong foot (here the reference is to the aggressive expansion plans of Indian companies in the period between 1995-98, which led to a prolonged slowdown since 1999, due to excessive supply and limited demand. Indian companies were left with a high incidence of debt, which was incurred to expand operations. This led to a significant hit on profitability as the debt incurred was at high interest rates and revenue growth was not sufficient to fund interest expenses sufficiently).



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