PERSPECTIVE

Living with Hardening Interest Rates

With the Reserve Bank of India increasing the CRR rate by 25 basis points to 9% and the Repo rate by 50 basis points to 9%, it is evident that the central bank is targeting to control inflation even if it means stifling the growth of the economy. In the past few months, the central bank has steadily curbed liquidity in the system by deploying its monetary tools.

While this may enable the government to curb inflation, it means a tough and challenging environment for the corporates. The corporates have already seen their interest expenses rising and their profits shrinking. Corporate results for the quarter ended June 2008 have shown that India Inc. has lower cushion on profits to cover the interest rate obligation.

An analysis of 1,500 companies has shown that the interest coverage, which shows the number of times the profits cover the interest costs, has come down to 2.2 times for this quarter. This was about 2.8 times for the same quarter last year. This drop is very crucial and shows how vulnerable a company is to rising debt costs on the one hand and the falling profits on the other hand.

Perhaps, India Inc. can learn how to handle this challenging situation by looking at the way the Indian auto majors like Tata Motors and Mahindra & Mahindra are dealing with it. These auto majors face a potential slump in their sales due to the increase in interest rates—reflected in vehicle loans, which the customers cannot afford. They know that the key to fighting this hike in interest rates is perhaps to reduce the price of their products which will enable their customers to buy the cars on their own without taking loans.

The purchase of automobiles through credit has dropped from 85% in the last quarter to around 65% for the quarter ending June 2008. Reducing costs is particularly difficult at this time as the costs of the inputs are rising by the day, but these companies are working on cost reduction strategies. They are also working on innovation and coming up with cheaper cars. Both these auto majors also have their own auto finance companies and are working closely with them to reduce the transaction costs and give loans to the customers at competitive rates. They are also working with the dealers and other channel participants to reduce their margins by convincing them that this is the best way to deal with the current situation.

Well, this is not the first time that the central bank has tightened liquidity in the recent past and all indications are that there may be much more tightening of liquidity in the near future. So, it is time for the corporates to work out strategies conducive to live with this hardening interest rate regime.

- D Satish