An Interest In High Interest Rates


There is much pressure on the RBI’s Monetary Policy Committee to rein in inflation. The external pressures are essentially from two constituencies—financial market commentators and the union government. But, exceptions and perfunctory statements apart, corporates seem to have been largely unconcerned with the RBI’s actions on interest rates or inflation. But, their interest in interest rates may have changed. They have new skin in the game. Let’s first see why they are largely unconcerned before we locate their new interest.

Corporates have de-leveraged. They have no need to borrow. The share of interest cost in their top-line or bottom-line has fallen. And, their cost of borrowing is low and also falling. Of all the possible problems faced by the corporate sector today in their business operations, the interest rate is perhaps, the least vexing.

Average debt:equity ratio of non-finance companies is comfortably below the sweet spot of 1. It was at a recent high of 1.17 in 2013-14. Since then, it has declined steadily. In 2020-21, it was down to 0.99 and preliminary results of 2021-22 at 0.72 suggest a further and significant fall.

In 2020-21, for the first time since at least 1990-91, non-finance companies reduced their outstanding borrowing i.e. they returned more funds than they raised debt. As a result, outstanding debt declined by 2.8%.

Preliminary results of 2021-22 show that outstanding borrowing declined by a further 0.5%. This is understandable. Companies have made huge profits in the past two years. Net profit reached Rs 5.9 trillion in 2020-21 and Rs 7 trillion in 2021-22 compared to an earlier peak of Rs 4 trillion in 2018-19.

While companies made huge profits, there wasn’t much scope of constructive use of these superlative profits because they decided to go very slow on creation of new capacities. A combination of very high profits and very low investment was behind the absence of the need to borrow.

Financial charges as a per cent of total expenses started declining from 2015-16 when its share was 5%. In 2020-21, this fell to 4.6% and is likely to have fallen further in 2021-22. Preliminary estimates show a fall to 3.4%, but this could be revised upwards.

Similarly, financial charges as per cent of profits before depreciation interest and tax fell from 36.4% in 2015-16 to 27.5% in 2020-21 and to 17.7% in 2021-22.

Interest incidence—the cost of borrowing—has been falling every year since 2015-16 when it was 9%. By 2020-21, interest incidence had dropped to 8% and preliminary data for 2021-22 suggest that it could have fallen even further—possibly closer to 7%.

The lack of appetite for borrowing and low concern regarding interest rates runs across companies of all sizes. For example, the top percentile (largest 1% companies) reported a shrinking of borrowing by 3.8% in 2020-21, the top decile (largest 10% companies) reported a shrinking of 3.4%. Other size groups saw negligible increase in their borrowing. The second decile saw a growth of 0.4% while the third decile saw no perceptible change and the rest also saw similarly very low growth in borrowing.

This lack of interest in borrowing is in spite of very low interest incidence rates. While the larger companies incurred an interest incidence of around 8%, the smaller ones faced a lower interest incidence. The lack of growth in fixed asset expansion is also similarly seen across all size groups of companies.

Evidently, corporates of all sizes don’t have much reason to care about interest rates in so far as capex investments or operations are concerned. But, they may care to some extent for the impact of interest movements for their treasury operations.

India Inc. has parked its superlative profits largely into their treasury operations. Non-finance companies increased their investments into equity shares by 14.5% in 2020-21 and then by another 15.9% in 2021-22.

Their investments into debt instruments grew by 8.2% and 28.4% in the two years. Their investment into securities as a whole is in excess of Rs 31 trillion. Of this, investment into debt instruments is of the order of Rs 4 trillion and there is another about Rs 3.8 trillion in mutual funds. Most of these investments can gain from rising interest rates.

A one percentage point increase in the interest rate yields an additional Rs 40 billion risk-free profit on the debt portfolio. There will be some more from the mutual fund portfolio as well.

A 7% return on investment seems better than the returns companies report on their net worth or on total capital employed. Corporates have turned to lazy business much like the banks had turned to lazy banking, a term popularised in the late 1990s by the then Deputy Governor of RBI, Dr Rakesh Mohan.

Rising interest rates could hurt investments into plant and machinery, not because of the cost of capital, but because of its payback in treasury operations.

As financial markets continue to deliver heady returns, corporates may not find the risk of investment into new plant and machinery as an attractive option. The fear of becoming a non-performing asset and turning into a stygmatised capitalist can be avoided if interest rates continue to remain high for a little longer.


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