Why high interest rates (and Rajan) are clearly not the problem

Most people agree that too much has been made of high interest rates and the causal RBI policy stance. Blaming Governor Rajan for high interest rates and high interest rates for India Inc’s ills seems myopic considering trends from Q4FY16 results of BSE100 companies.

As per research by Credit Suisse, so far in Q4FY16, the number of companies out of the Top 100 with Interest > EBIT (i.e. companies unable to come up with enough operating income to even cover interest outgo) is only seven: Tata Steel, JSPL, SAIL, Reliance Communications, United Spirits, and Cipla. Mind well, the post crisis peak for the number of cos is just 10, so we clearly aren’t exactly in the throes of agony! These Magnificent Seven have reached their dubious distinction due to a combination of stupidity, poor governance, corruption and/or an adverse commodity cycle. Not high interest rates.

Another fact coming out of the Q4 trends is that while aggregate ‘Interest / EBIT’ has indeed climbed, it has begun to recede from a peak of ~20% in Q3FY16. Even at its worst, it shows that the Top 100 companies had 80% of their operating profits available for taxes, distribution as dividend and for transfer to reserves AFTER interest outgo. Hardly a ‘hand to mouth’ existence!

Besides this, common sense suggests that following Subramanian Swamy’s (and to a lesser extent, Arun Jaitly’s) simplistic suggestions of slashing interest rates to end industry’s misery fails

a) Transmission Of Rate Cuts Is Suspect

In the past, RBI has hauled up banks for not passing on rate cuts on to borrowers. Two reasons why banks have not been benevolent are: a) The repo market is not the primary source of funding for banks; and b) banks are currently grappling with the massive problem loans elephant. Full recognition of all stressed assets could bloat the number to above INR 10 lac crores or ~18% of total lending. This is impacting profitability and reducing borrowing costs simply isn’t an available choice.

b) Impact Of Rate Cuts Is Suspect

Even if rate cuts are transmitted further down, the ability of lower interest rates to stimulate growth is debatable. Scaling up Government investment isn’t possible with fiscal constraints and the private sector is unwilling to invest unless demand goes up significantly. Rate cuts alone are unlikely to create this demand and if demand revives, interest rates aren’t going to matter.

c) Savings Squeeze Resulting From A Rate Cut

For sustainable growth, a high savings rate is essential. The last rounds of rate cuts had little impact on borrowing costs but led to reduction in deposit rates; basically, banks kept charging borrowers the same rates and paid depositors less! If rates are reduced further, real interest rates on bank deposits will start approaching unviable levels.

Blaming Rajan for high interest rates and high interest rates for everything under the sun is reductionist thinking.

 

 

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