An increase in the repo rate has put small businesses on the back foot yet again. How will they cope this time?
IT is well known that small and medium enterprises (SMEs) are among the worst affected, when interest rates rise rapidly. Accordingly, these companies have been starved of funds of late, with the surge in interest rates in the last few months threatening to cripple their growth.
In such a scenario, further rise in interest rates was the last thing these companies were expecting. But, contrary to such hopes, the Reserve Bank of India (RBI) early in June hiked the repo rate—the rate at which banks borrow from the central bank for short-term—as part of its attempts to contain inflation.
The hike at 25 basis points raised the repo rate to 8% has resulted in the banks’ lending getting costlier. This has left SMEs fuming as it comes at a time when they are coping with rising raw material costs and an uncertain business outlook.
Domestic apparel supplier Bang Overseas is among those affected. For some time now, suppliers like us have been on the receiving end as retailers had been bargaining hard for prices. Somehow, we were managing the demand side but now the repo rate hike has left us with no choice but to borrow at higher rate. This increases our input costs, while the price we get for our products keeps getting lower if we want to remain in competition.
Going by the existing rate of inflation, which touched a 13-year high of 11.87%, it appears SMEs will would have to endure more pain as the central bank is unlikely to halt its monetary tightening measures soon. Economists expect few more hikes in the repo rate and the cash reserve ratio (CRR)—the minimum cash banks need to hold with the RBI—in its attempts to check inflation.
“We think there has to be significant further tightening to arrest inflationary expectations, second-round effects and demand pressures. We now expect the RBI to hike another 100 basis points (BP) through a combination of raising the repo rate (50 bp) and the cash reserve ratio (50 bp) over the next three months,” says a recent client note by Goldman Sachs economists.
This hike in the repo rate is signal from the RBI to banks that deposit and lending rates are headed higher. When the central bank hikes the CRR, it aims to mop up money available with commercial banks, thereby leaving behind little money for them to lend. In the last many months, the central bank has used CRR as a measure to fight inflation. A host of monetary tightening measures by the RBI in the last couple of years has resulted in banks’ lending rates rise by 5-7%.
The jump in lending rates has hurt SMEs more than their larger counterparts who have been able to bargain better with banks on borrowing rates. Also, with various other fundraising options such as overseas borrowing and quasi-debt instruments at their disposal, larger companies have never really been short of cash. SMEs have been unable to tap these sources due to their smaller balance sheet size and lack of adequate credit ratings.
The recent stock-market crash has dealt an additional blow to these SMEs with their promoters unwilling to sell their stake to private equity firms or other institutional investors, at lower valuations.
The hike in repo rate has definitely affected our winery business because it requires us to depend on banks for loans. Since loans are more expensive, we have to look at alternate ways to pump money into our business, though we hope this situation does not continue for long, and does not become worse here onwards
In India, most SMEs are heavily dependent on banks for their credit requirements unlike, say, in the UK where SMEs have been able to raise funds through the Alternative Investment Market (AIM). While there are plans for a dedicated stock exchange for small and medium enterprises (SMEs) to tap the capital market, analysts are unsure about the success of such a venture as proposals indicate that access could be restricted to a limited investor base.
Lack of funding options for SMEs may prove to be detrimental to the growth of the economy since they contribute roughly 40% to the country’s total domestic production, and close to 50% of India’s total exports. Analysts point out that though all emerging companies have been affected by the recent hike, the worst hit are the ones in the real estate sector. Mid-sized firms, excluding real-estate and construction entities, have been raising funds at 11-12% from local market, while the smaller ones get finance at roughly 14% against 7-10% earlier. Real estate and construction companies are said to be borrowing at 17-18% or more. There is lot of liquidity crunch for players in real estate space due to the repo rate hike. Though a player in this space can pump funds in his business through various means, borrowing from banks is the most important.
Bankers say higher interest rates are deterring the expansion plans of several emerging companies. Most of them are not only going slow on expanding their existing capacity, but also deferring their M&A plans due to lack of funds. Earlier, entrepreneurs were thinking of diversifying investing abroad and even in India and but now they are more cautious. Moreover, banks have also turned cautious about lending to them fearing defaults in a deteriorating business environment. We have to be cautious while extending loans in this situation and so it’s obvious that some emerging companies may not be very happy with the banks. A senior executive at Polyplastics, a Haryana-based auto component company, says, Getting a loan for our business has become immensely difficult post the repo rate and this has definitely affected our business in many ways.
But, not everyone is glum about the situation. If you see the rise has just been nominal at 25 basis points and moreover the fixed deposit rate has been increased too, so that is an additional income for the people borrowing from us. Yes, the repo rate could affect SMEs marginally but one must also consider that earlier lending rate of 7% was unrealistic and now the present rate is more realistic. Presently, we lend to emerging businesses anything between 14 to 16 percent but that has not resulted in less number of companies lining up for credit.
REPO CARD
Recently the RBI hiked the repo rate (the rate at which it lends to banks) to 8% This could affect SMEs who depend heavily on bank borrowings unlike their large counterparts The lack of alternatives such as quasi-debt instruments and overseas borrowings put SMEs at a disadvantage
