Interest rate hikes start to pinch Indian small businesses | Business and Economy News

Mumbai, India – In recent months, Neetee Clothing, a small fashion apparel manufacturer and exporter based in Gurgaon, has cut its working capital loan from its bank by 80% as India’s central bank raised interest rates to two. occasions since May in an effort. tame galloping inflation.

As the company dips into its cash reserves at the moment, chief executive Animesh Saxena told Al Jazeera he fears this may not be a sustainable strategy in the coming months when his company’s peak season begins. .

“We are again worried about the high season which is October to November when we will have to buy a lot of raw materials and by the time the shipment takes place and the payment starts to come in there is a delay of four to five months,” he said. .

Saxena is not alone. Rapid increases in lending rates in India are prompting many medium, small and micro enterprises (MSMEs) across the country to reduce their reliance on institutional loans as they are unable to afford the rising interest charges .

This is the latest challenge for these companies, which for some years have already seen their profit margins shrink with rising raw material costs and a slowdown in demand due to the pandemic and the Ukrainian-Russian war. Now analysts are worried about how long it will take before these companies exhaust their internal sources of funding and remain stretched thin.

Since May, the Reserve Bank of India has raised the repo rate twice by a total of 90 basis points, showing a sense of urgency to rein in inflation which has reached unprecedented levels.

The repo rate is the rate at which the RBI lends money to commercial banks and at which all saving and lending rates are benchmarked. As the central bank increases this rate, banks also increase the rate at which they make loans and accept deposits.

A change in banking policy in September 2019 means that small and medium-sized enterprises, which until then borrowed loans at a rate set according to the bank’s marginal cost of lending – the minimum lending rate – will now borrow at a linked rate directly at the repo rate. In other words, these small businesses will see the interest on their loans rise or fall instantly with every change in the repo rate by the central bank. In December 2021, 69.2% of outstanding loans to MSMEs are priced at a rate linked to the repo rate, compared to 1.8% at the time of the rule change.

Of all the loans given to companies, MSMEs have the largest share of loans to be linked so closely to the repo rate. This makes these small businesses – which employ around 120 million people and contribute around 30% to India’s gross domestic product, earning them the nickname “the backbone of the national economic structure” – more vulnerable to the burdens of higher interest with each increase.

“Twin Challenges”

“Companies face a dual challenge – operational and financial, and this is more relevant to SMEs,” said Soumyajit Niyogi, Director, Core Analytical Group, India Ratings & Research.

High input costs and general weak demand have led to operational difficulties for MSMEs as profit margins shrink. Niyogi points out that while the cost of loans is on the rise, the loan needs of businesses are also increasing, given the increase in working capital requirements.

Neeraj Kedia, managing director of Chakradhar Chemicals, a medium-sized company that manufactures micronutrients and soluble fertilizers, as well as agricultural equipment, said the company has started to reduce its share of working capital debt as it could not afford such high interest rates.

This is even though Kedia’s business hasn’t faced much difficulty over the past two years, as industries such as fertilizers, pharmaceuticals and food have fared quite well during the pandemic.

Unlike Saxena’s textile business, which was not spared. A sharp rise in input costs – raw cotton has increased by 100% – over the past year and a half has left his garment manufacturing business struggling to stay profitable.

Rising raw material costs were “a blow” as customers were “unwilling to accept” the full price increase, Saxena told Al Jazeera. “We had to reduce our margins and production costs,” which meant that if the cost of their finished goods increased by almost 25%, they could only increase the purchase price by about 15%. Now, with banks’ lending rates rising, “interest costs will also rise and that will be another challenge for us,” he said.

A June 6 research report by the State Bank of India on the first hike in repo rates said the 40 basis point hike will raise interest costs for MSMEs by 54.41 billion rupees (685 million), while another 75 basis point hike would raise interest costs for both. MSMEs and personal loans segment of 231.14 billion rupees ($2.91 billion).

A decline in profit margins aside, experts are concerned about whether these companies will be able to repay the loans they have taken out over the past two or three years given the aggressive rate hikes expected.

Currently at 4.9% – while the repo rate is still below the pre-COVID level of 5.15% – analysts expect it to cross it as early as August. A June 8 SBI research report expects the political repo rate to hit 5.25% in August and 5.5% in October and expects it to peak at around 5.5 -5.75%.

Snowball effect

Workers make parts for household mixers in a workshop in Mumbai, India
MSMEs do not blame a single Black Swan event for their current problems [File: Danish Siddiqui/Reuters]

As Niyogi puts it, the disease of MSMEs is not rooted in a single factor or a single Black Swan event such as the war between Russia and Ukraine. A series of unfortunate events have snowballed the situation today.

MSMEs saw a drop in consumer demand even before the pandemic hit due to demonetization when the Indian government invalidated most of the currency in a sudden move in November 2016, and through the pan tax. -Indian on goods and services which was subsequently triggered. summer.

More recently, the Russian-Ukrainian war which began more than four months ago has driven up the prices of raw materials, including that of fuel, which has seeped into the cost of production of almost any good or service , making inflation more universal. As a result, central banks around the world have tightened monetary policy in an attempt to control domestic inflation.

For India, global oil prices are a greater cause for concern as the country imports almost all of its needs, which in addition to sinking a hole in its trade balance also depreciates its currency, making imports more expensive. .

For MSMEs, as for other segments, as raw material costs have risen, high inflation has also led consumers to delay spending on non-essential items, which has hurt business profits.

Anil Bharadwaj, secretary general of the industry body, the Federation of Indian Micro, Small and Medium Enterprises (FISME), said that the prices of raw materials, whether steel, copper, of aluminum or plastic raw materials, have increased by 30 to 40%. and, in some cases, up to 100%, which limits the money available for day-to-day business.

Add to that higher loan interest rates and he fears it could cripple some of those businesses that had so far survived, including during the early months of the pandemic when India was locked down to curb the spread of the virus.

“Especially for companies that have been in debt, that had taken out term loans for the last five to seven years, this 90 basis point hike in interest rates is going to make life harder for them,” Bharadwaj said. at Al Jazeera. “It is important to alleviate some of the pain of these MSMEs, otherwise there is a risk that they will become NPAs [non-performing assets].”

With the first installment of repayments against the emergency credit line of credit program extended by the government to battered MSMEs during the COVID lockdown expected next year, it will be a difficult road to travel for several small and medium enterprises, warn the experts.

Jobs against inflation

While interest rate hikes are imperative to ease inflationary pressures, the pace and amount of hikes have made the situation grim, experts say. The balance between growth, employment and inflation is crucial.

“I think we have to be careful how much we raise pension rates,” said Ananth Narayan, associate professor at SP Jain Institute of Management and Research. “If you raise repo rates quickly just because market watchers and economists are calling for it when you don’t have [companies taking loans]what are you trying to address? »

A rapid rise in interest rates “is likely to create far more problems for the real economy and job creation and MSMEs than you will deal with inflation. The impact on growth will be much greater than that on inflation,” he warned.

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