Lending rates set to rise
Since Oct 2019, all banks were mandated to lend at floating interest rates linked to the External Benchmark-Linked Lending Rate (EBLR) to make transmission of monetary policy rates effective.
EBLR has been linked to an external benchmark such as the RBI repo rate or Treasury Bill yield. Hence, a rise in repo rate implies a higher cost of borrowing for commercial banks, which will lead to a simultaneous rise in interest rates on loans.
Would the mid-market debt be impacted?
Assuming a quick and equivalent transmission of repo rate, the mid-market enterprises that are heavily reliant on the loan market expect to be impacted due to the rise in bank EBLR. Also, the immediate linkage of mid-market debt to bond yields has been found to be stronger with respect to the hike. For instance, if we consider the A-rating space (refer to the chart), the yield has nearly absorbed the repo rate hike on May 4.
Impact on mid-market debt in the Non-Financial Services sector
A rising rate environment is unfavourable for mid-market enterprises, particularly in the discretionary sectors, as well as for long-tenor infrastructure projects with fixed returns. However, companies with established brands can pass on the rise in costs due to a hike in interest rates to consumers. The overall impact expects to be less significant though due to the lower leverage of the corporates on average compared to the previous rising rate environment.
Impact on mid-market debt in NBFC
The rate hike could lead to an immediate uptick in the cost of borrowings for most NBFCs from Q2FY23, impacting their Return on assets (ROA) for a couple of quarters. However, the overall impact on their Net interest margin (NIM) could be limited as the pricing of loans is also expected to increase. If the proposed RBI framework to remove the interest rate ceiling for NBFC-MFIs is implemented, all segments of retail credits are expected to be less impacted.
What about economic growth?
The Indian economy expects to continue its journey on the recovery path due to normalcy in activities post the third wave of Covid, resurgence of private consumption and discretionary spending, and the forecast of a normal monsoon supporting rural demand. Capacity utilisation of India Inc. went up ~72% for the manufacturing sector in Dec 2021 quarter from ~68% in the prior quarter. Imports of non-oil, non-gold, silver and precious metals imports, which is a measure to gauge the strength of the domestic demand, rose ~30% in Apr 2022.
The Federal Open Market Committee chair in the US has also emphasized that ‘growth will remain solid in 2022’ and expects private sector balance sheets to be strong enough to bear the impact of a tightening monetary policy.
Impact on our products
We see no implication on the fund’s current investments. With the increase in the yield, the mid-market player will become dependent on alternative lending sources which will increase the scope for debt asset managers to negotiate for better yields.
The views provided in this blog are the personal views of the author and do not necessarily reflect the views of Vivriti. This article is intended for general information only and does not constitute any legal or other advice or suggestion. This article does not constitute an offer or an invitation to make an offer for any investment.