Rediff India Abroad
 Rediff India Abroad Home  |  All the sections

Search:



The Web

India Abroad




Newsletters
Sign up today!

Get news updates:
  
Mobile Downloads
Text 67333

Home > India > Business > Special

   Discuss   |      Email   |      Print   |   Get latest news on your desktop


'Will high interest rates kill investment growth?'

Business Standard | July 02, 2008

With high investment levels fuelling much of the current GDP growth, the impact of the credit squeeze is more than a matter of academic interest.

Sheshagiri Rao, Director-Finance, JSW Steel [Get Quote]

"Apart from rising costs, there is the issue of liquidity drying up - this will hit both new and expansion projects which haven't been funded as yet."

The Indian economy has recorded an impressive GDP growth rate close to 9 per cent for the last three years, facilitated mainly by robust domestic demand and availability of capital at competitive rates to finance this growth. The economy showed resilience inspite of the financial crises triggered by the US subprime problem.

Even though the RBI has been cautious in formulating its monetary responses by gradually increasing the repo rate and CRR, inflation has crossed the tolerance limit. Fiscal measures like removing import duties and imposition of export duties do not seem to have any effect in bringing down inflation, since this inflation is a result of an unprecedented increase in international oil, food and commodity prices.

When the Indian industry is beset with rising input costs, depressed equity markets, higher credit spreads on borrowings on overseas loans due to credit crunch, the recent steep hike in CRR and repo rate will not only push up the borrowing cost but also affect liquidity in the market.

A slowdown in demand is imminent in view of the higher interest rates and availability of credit.

The rise in interest rates is causing a serious concern among companies. With inflation touching an all time high, there has been a substantial increase in the interest cost on both short-term and long-term loans as banks have already started hiking PLR. Higher cost of funds will affect industry, construction and other economic activities. Growing interest costs will result in reduced consumption and investment expenditures. As a result, aggregate demand is likely to be hit.

The cost of borrowing and availability of capital would result in reduced industrial investment adversely affecting both upcoming expansion plans and greenfield projects. However, companies that have already achieved financial closure for their upcoming projects will have little or no impact. The current hike will reduce the pace of economic growth at the time when the capex cycle is at its peak.

Companies shall feel actual impact only around the third or fourth quarter, with a further downslide in EBITDA margins.

Some interest rate-sensitive sectors like infrastructure, auto, realty and finance are already reeling under the effects of high inflation. The March-end financial results clearly show that corporate India is feeling the heat. The dip in margins will reflect on operating leverage and cost pressures.

Beyond a certain level, the sale price (in every sector) cannot be increased and continuous rise in input costs will adversely affect profit margins. Banks will also be hit as higher interest rates will lead to lower credit growth and impact their bottom line.

This will keep investors away. But then, it's not just the cash with banks but the state of the equity market and interest of foreign investors that will determine whether corporate plans are on track. This time around, unlike in the early 1990s, the bulk of funding has taken place through equity issues and internal accruals.


Mahesh Vyas, CMD, Centre For Monitoring Indian Economy

"Output prices are rising faster than interest costs are, and while EMIs will hit consumer demand, new investments create new demand"

An increase in interest rates can hurt investments in two ways: First,  high interest rates raise the cost of setting up an investment project. As the cost of funds of a project keeps rising, it makes the project's payback time increasingly longer. The consequent increase in uncertainty of the project can lead to promoters postponing implementation of new capacities till funds get cheaper.

Second, high interest rates can hurt consumer demand as demand is, in an increasing number of industries, driven by the easy availability of cheap credit. If demand slows down, promoters would postpone expansion plans.

Currently, high inflation keeps the first problem at bay. New capacities in say, steel and cement see greater benefits in the high prices obtained in the market for these products compared to the increase in costs because of higher interest rates. Prices of steel and cement have risen by 25 per cent and 12 per cent in the last one year. The increase in interest rates are small compared to this - the average PLR is up a mere 6.7 per cent, from 12.75 per cent in March 2007 to about 13.6 per cent in June 2008.

The Indian market is expanding at a rapid pace and industrialists cannot afford to let competition take away market shares in this scenario. CMIE predicts that the real GDP would grow by 9.5 per cent in 2008-09. This would be the fourth consecutive year of over-nine per cent growth in real terms.

In nominal terms, the markets are growing at close to 15 per cent per annum. The rise in interest rates is too small to deter industrialists to continue to expand capacities to gain or maintain their market shares. Expansion is necessary because most industries are running at peak capacity utilisation levels.

The danger from consumer demand slowing down is greater. Indian households are more geared today than anytime in the past. EMIs determine the level of additional spending power. And, any rise in interest rates that leads to an increase in EMI levels directly hurts the spending capacity of the Indian household. And, EMI levels have risen because of the recent increase in interest rates.

However, there are reasons why aggregate demand has not been badly affected. First, the increased investment since 2004 has increased employment. This process of fresh investments leading to new employment continues to chug and creates additional demand.

Secondly, and more importantly, the tax breaks provided by the last budget have increased the post-EMI budgets of a large proportion of the households. This is an important cushion against rising interest rates. No wonder, no retailing company is complaining about high interest rates or high inflation hitting demand, yet. Domestic consumption demand is robust and it continues to fuel the capex plans of companies.



Powered by

More Specials

   Email   |      Print   |   Get latest news on your desktop



Advertisement
Advertisement