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RBI rate hike to hit corporate margins
July, 27th 2011

The Reserve Bank of India's move to hikepolicy rates by 50basis points (100 basis points = 1%), compared to the 25-basis point that mosteconomists and analysts were expecting, is sure to hurt corporate profitability as banks pass on the higher costs of funds to their borrowers.

The central bank also said that banks have agreed to pass on the rate hike toborrowers quickly so that the transmission mechanism is much faster this time. For example, within hours of RBI's decision on rates,Yes Bank raised its lending rates by an equal amount and said this would help it absorb the impact of increased rates. It may be noted that after the 25-basis point hike in rates in June, some banks had absorbed the impact and did not hike their lending rates.

Going forward, market players said companies in the interest rate sensitive sectors like real estate, automobiles, capital goods are expected to be affected more than the other sectors. And as banks begin passing on the impact of RBI's decision, corporate revenues and profitability for the quarters ended September and December would be under stress, they said. "It gives a clear indication to fiscal managers to take appropriate action in terms of shifting and correcting the fiscal spend towards capacity building and not just consumption and subsidies .

The unfortunate implication is a potential ratcheting down of economic growth as investment spending becomes a tougher call for the private enterprise.

Certain sectors are bound to see a tapering off in consumption driven demand although the long term opportunities are intact in nearly every sector as Indian demographics are still very compelling," said Sanjay Nayar, CEO KKR India.Economists and analysts agree that with each rate hike, it is becoming increasingly more difficult for the central bank to further increase its policy rates. They also agree that the rate hike decisions by banks post the central bank move have also not been secular.

A recent report by Sidhhartha Sanyal, India chief economist, Barclays Capital, pointed out that between November 2010 and July 25, while the RBI had raised rates by 125 basis points, banks on an average have hiked their base lending rates by about 165 basis points. For RBI, this was the 11th hike in rates since March 2010, and this continuous spate of increasing rates, mainly to contain the rate of inflation that is much above the central bank's comfort level, corporate earnings have been under pressure over the last three quarters.

"The consensus earnings estimate was already downgraded by about 7-8 % in the last three quarters," said Sampath Reddy, CIO-Equities , Bajaj Allianz Life Insurance. There are indications that the earnings growth for large corporates is largely back-ended with the expectation of a rebound in growth in the second half of the current fiscal.

"With policy action not being conducive to high growth and interest rates remaining elevated for the remainder of the year, the earnings growth estimate could witness further downward revision," Reddy added.

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