Rate Hikes in India - Part 2: Effect on Corporations

The previous post had given an introduction to the sectors that could face trouble due to the rate hikes. We will go further on analyzing the ramifications.

First, the rate hike would pressurize a fledgling banking system in India. Indian banks are tiny compared to world standards, inspite of India having one of the deepest and oldest financial markets and some of the best talent in this arena. One of the main reason for this is the over meddling of Indian government in its affairs. Now, things are going for worse. The Prime Lending rate in India has climbed above 12% for many banks, while you could borrow at 5% in Libor (London) or around 1% in Yen nominated loans from Japan. And, given that Indian rupee has bullish prospects both in short & long term, the overseas loans would have an effective rate of less than 3% in rupee terms. To add to this, recently Standard & Poor has upgraded India's ratings and thus, Indian corporations could get better rates due to lesser perceived risk. Thus, any corporation that could borrow from overseas will skip Indian banks and get it at the concessional rates. So, when you read about Tata or Birla's mega acquisitions and dont read any Indian bank acting as the banker for the deal, dont be too surprized. By being burdened with enormous rates, Indian banks lose out the best customers and have to be put up with the lousy ones.

Second, RBI would slowly lose control of Indian market. By forcing more companies to look outward for loans, RBI has little leverage over the market and over the course of time market would act independent of RBI's whims & wishes and long term rates would be less under control. This is somewhat similiar to the situation with US Fed that has control over short term rates but has little control over the long term rates. While, it is debatable whether RBI should have greater control over the economy or not, but an economy totally running out of governmental controls might get reckless if the markets are not mature and deep.

Third, small & medium scale enterprizes would lose out of competition. Large concerns like Tata, Reliance, Birlas, Essar, etc. could borrow at international rates, while their smaller rivals back home cannot do that and have to put up with twice the cost in interest rates. In many businesses that run on lower margins, a small change in the rates could topple the competition totally towards other side and kill a lot of fledgling enterprises that is essentially not good for the country.

In Part 3, we would see what other steps India could take to counter the current inflation crisis