After two years of high interest rates with periods of ‘higher for longer’ in between, the market has not given much importance or attention to the US Fed Chairman’s comment that “the time has come to cut the policy rates”, or the hope that India may also embark on a rate-cut cycle sooner or later.
We analysed 250 largest companies, by market cap, but excluding BFSI, to highlight the reasons for the tepid response.
Lag in pass through
The interest rate reflected on companies’ Profit & Loss statement does not immediately track the repo rate. It does so only to a limited extent and after a lag.
There are two sharp movements in the repo rate in the last seven years to observe. As seen in the accompanying chart, the repo rate moved down 230 bps, from 6.3 per cent in March 2019 to 4 per cent by March 2021 as part of the Covid stimulus.
The cost of debt (finance cost to average net debt) contracted by a mere 60 bps in the period.
Similarly, the cost of debt rose 160 bps from there on to 9.6 per cent currently in response to a 250 bps rise in the repo rate in the last two years. While the cost of debt in FY24 is the highest in the last seven years, the impact of higher interest costs on PAT is much lower (see charts).
This is because debt itself has reduced on the aggregate. Thus, going into a rate-cut from this base may not have a big positive impact on India Inc’s profitability and earnings.
On three metrics — the debt-equity ratio, the net debt to EBITDA ratio and annual growth rate of debt — debt has played a shrinking role. Either due to conservatism or drawing hard lessons from earlier capex cycles, the debt-equity ratio at 0.72x as on March 2024 is at its lowest since March 2018. Even measured on the P&L, the net debt to EBITDA metric at 1.56x is at its lowest and is an even sharper contraction owing to the rise in operating profitability. The net debt has remained flat in FY24 compared to an EBITDA growth of 25 per cent YoY in FY24.
Impact on PAT
As mentioned earlier, interest cost as a percentage of PAT has declined from FY20 levels, limiting the impact of rate cycle. For instance, interest costs for ₹100 of PAT was ₹41 in FY18, increased to ₹61 in FY20 and is now at ₹34. Ceteris paribus, a 100bps decline in interest costs will lead to 2.5 per cent increase in PAT. Owing to a lag and uncertainty about complete pass through, the savings should hardly be discounted at the current stage.
The impact will be higher for sectors that are highly indebted or with a high cost of debt. Amongst the key sectors, it will be power generation and steel that can witness a 6-4 per cent improvement in PAT on a 100 bps decline in their respective interest rates. Paper, textiles and agro chemicals are sectors that can gain the most on any lowering in interest costs, as the accompanying chart shows.
However, at an overall level, more than interest cost savings, investors will have to observe whether companies go back to debt in the upcoming rate-cut cycle. With private capex so far being lacklustre post Covid, the role of debt had shrunk in the expansion cycle. Taking cues from fiscal announcements, India Inc can re-engage its borrowing arm to find additional return from financial leverage, which has been lacking so far.