Rate rise blues for India Inc

The going has become that much tougher for corporate India. With the Reserve Bank of India (RBI) raising key policy rates (repo and reverse repo) by a steep 50 basis points, India Inc is staring at rising cost of capital.

This in times when input prices are soaring and impacting margins adversely will put further pressure on earnings and future plans.

Signs of a slowdown are already evident. Growth in gross fixed capital formation is moderating, IIP numbers are flagging, and business confidence is certainly down.

RBI moves will further add to corporate woes. Harsh Mariwala, the president of industry body Ficci, said, "I am afraid that with such a hawkish monetary stand, the investment environment would become even more difficult. Growth and employment targets will certainly not be achieved."

While RBI's intent to contain inflation is a right step on a macro basis, cost of borrowings are likely to go up as credit offtake picks up during the latter half of the year.

V Ashok, Group CFO, Essar Group, said: "With no respite in sight as regards inflation, there is a possibility of further rate increases, which may derail investments and growth. Increase in crude oil prices and commodities has already affected the earnings of the corporate sector and further increases in cost of borrowing will hurt profitability and retail spending."

While a rate hike was a foregone conclusion, what has really come as a surprise to many is the steep increase of 50 basis points at one go.

Corporate India believes that since no measures have been taken by the central government to deal with the fiscal situation by passing on the rise in fuel prices, the only measure left with the central bank was to increase policy rates.

Harsh Goenka, chairman, RPG Enterprises, said: "RBI's move of raising key rates by 50 basis points is a bit of a surprise, given that a 25-basis-point hike was generally expected.

However, with inflation showing signs of actually coming in the way of growth, it is perhaps understandable that the central bank has chosen to attack price rise head-on."

For certain sectors, the going will become that much more difficult. For instance, rate-sensitive sectors like automobiles, infrastructure, real estate and construction could be hit quite badly. The latest rate rise will further push the cost of construction up for developers.

Banks have already taken a cautious approach to real estate lending and reduced their exposure to the sector. Most developers are now prevailed upon to raise a larger component of their construction costs from the private sector.

The fact that such funds come at a higher cost of borrowing has already increased their construction costs significantly.

Rajeev Talwar, group executive director, DLF, said: "I think it is the last-ditch attempt; beyond this they can't increase rates. They are waiting for the good crop and see what can be done on the rate front.

If banks increase rates, it will definitely impact growth. I think instead of increasing rates, they have to concentrate on increasing supply. When you have to balance the losing edge of competitiveness, you have to increase the ease of business.

By ease of business, I mean faster clearances, more projects on the group. Otherwise, inflation will be under control but unemployment will be out of control. The government should decide whether it wants development or inflation control."

The automobile sector's big daddy, Maruti Suzuki believes that a 50-basis-point rise in rates will definitely impact the overall scheme of things.

Ajay Seth, chief financial officer of Maruti Suzuki, said, "There will be more pressure on demand and off-take moving forward. It will not be easy for the industry to deal with the situation."

Though the government has not passed on the oil price rise to customers that will further stoke inflation, experts feel it has worsened the fiscal situation.

Vibhav Kapoor, chief investment officer of IL&FS Investment Managers, said, "The fiscal deficit is high. The government has not passed on the increase in oil prices and, therefore, will have to borrow more to fund the deficit. The government will need to do its part and increase prices to reduce the burden on exchequer."

What worries many is not only the current increase in key rates but a further tightening. Many believe that the repo rate (currently at 7.25 per cent) has still not touched the 2007-08 levels of 9 per cent.

So, there is more room for further increases. But it would dampen growth prospects of the private sector.