India Inc's earnings may take a hit in coming quarters as rates rise

Listed non-financial firms had saved nearly Rs 1 trn because of decline in interest rates in FY21, FY22

Two successive rate hikes by the Reserve Bank of India (RBI), including the 50-basis-point (bp) increase announced on Wednesday, and the resulting reversal in the interest rate cycle could hit corporate profitability in the coming quarters.

This is because India Inc gained handsomely from a decline in interest rates in financial year 2020-21 (FY21) and FY21 after the central bank cut the policy rate to a record low of 4 per cent in May 2020 and expanded liquidity after the outbreak of the Covid-19 pandemic.

In all, companies in Business Standard’s sample saved nearly Rs 1 trillion from the decline in interest rate in FY21 and FY21, which boosted India Inc’ bottom line. As a result, India Inc’s interest burden eased despite a steady rise in overall corporate borrowings.

The combined interest burden for listed companies excluding banking, financial services, and insurance (BFSI) declined 7.3 per cent between FY20 and FY22, even though there was a 12 per cent rise in borrowings.
 

The analysis is based on a common sample of 963 companies ex-BFSI that are part of the BSE500, BSE MidCap and BSE SmallCap indices. The companies in the sample reported record high gross borrowings of Rs 36.08 trillion at the end of FY22, up 2.7 per cent year-on-year (YoY) from Rs 35.12 trillion. Their combined interest payment, however, declined 3 per cent YoY to Rs 2.51 trillion in FY22 from Rs 2.59 trillion in FY21, and record high of Rs 2.71 trillion in FY20.

The combined net profit of these non-BFSI companies rose 63.6 per cent YoY in FY22, even though their operating profit (or Ebitda) rose just 27.4 per cent YoY, and combined net sales increased 31.1 per cent YoY. The bounce in earnings growth came from the 3.1 per cent YoY decline in interest cost and a slower 7.3 per cent rise in depreciation allowance.

Two successive reductions in the policy rate by the RBI in 2020, coupled with a massive infusion of liquidity, resulted in a sharp decline in interest rate, benefitting all borrowers.

For example, the yield on the benchmark 10-year government of India bond declined to 5.96 per cent on average in FY21, the lowest in at least a decade. The decline in corporate borrowing costs was even sharper, as it fell 177 bps in the last two years from 8.82 per cent on average in FY20 to 7.05 per cent on average in FY22.

India Inc’s borrowing cost in FY22 was the lowest in more than a decade and acted as a tailwind for corporate profits.

Analysts say the incremental rise in the interest burden after the hikes will be a double whammy for non-financial companies that are already suffering from a decline in margins thanks to higher raw material and energy prices.
 

“The overall corporate earnings in FY23 will be at least 15-20 per cent lower than what the market expected at the beginning of the current fiscal. The earnings will be affected by a host of factors, including lower top line growth, higher input price, and rise in borrowing costs,” said Dhananjay Sinha, managing director and chief strategist at JM Institutional Equity.

Banks and non-bank lenders were the biggest gainers from the decline in interest rates. Their combined interest cost declined 3.7 per cent YoY in FY22, despite a faster rise in their loan book and the asset base last fiscal. In comparison, their overall asset base rose 10.7 per cent in FY22. As a result, lenders’ average cost of funds declined to a record low of 3.83 per cent in FY22 from 5.14 per cent in FY20.

The rate hikes are expected to raise banks’ costs of funds as well, but market participants expect them to more than make up for it by raising lending rates.

The risk is that a rise in lending rates could lower demand for retail credit even as higher inflation hits growth in their loan book.