Mumbai, Aug. 3: The perceived wisdom is that a cut in interest rates will re-ignite a sputtering economy.
And that’s why India Inc has been clamouring for a rate cut for close to a year, turning resentful after the RBI flagged inflation as its primary concern that should serve as the nominal anchor for the conduct of its monetary policy.
A study by India Ratings and Research, a Fitch group company, has questioned the common belief that a rate cut is always good for companies.
The study posits a contra view: it says that a rate cut can actually hurt the bottomlines of companies that are net importers.
Here’s why: in the last four instances of a repo rate cut since March 2010, the study says, the rupee depreciated on three occasions one month after the rate cut. The average and the median depreciation of the rupee in these three instances was 4.1 per cent and 5.2 per cent, respectively.
Around 53 per cent of the companies that figure on the BSE 500 have historically suffered a 1.3 per cent erosion in their earnings before interest, tax, depreciation and amortisation (EBITDA) for every 1 per cent depreciation in the rupee.
It goes on to paint two scenarios: a 25-basis-point cut in the interest rate followed by a 2 per cent depreciation in the currency will see the amount of stressed debt of BSE 500 companies increase to 14 per cent from 10 per cent at present.
If there is a 50-basis-point repo rate cut followed by a 5 per cent depreciation in the rupee, the stressed debt will rise to 21 per cent.
“The benefit of a lower interest rate is thus often muted and, in some cases, the impact on credit metrics such as coverage ratio is actually negative,” the study adds. Debt service coverage ratio measures the amount of cash flow available to meet annual interest and principal payments on debt.
The study says a reduction in the repo rate does not automatically translate into lower lending rates. However, the rupee reacts almost immediately. “It is thus possible that there is a phase after a rate cut where the currency could depreciate while the interest rate benefit is not transmitted to the borrowers. Net importers are, therefore, likely to be more severely impacted than suggested in this study, which assumes immediate transmission of an interest rate cut.”
A rate cut will, therefore, not immediately lower the debt servicing burden of companies and any perceived benefit for over-leveraged firms will be undermined by the depreciation of the rupee.