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Raghuvir Srinivasan

Companies seem to be benefiting from the soft interest rate regime tremendously as they go about substituting existing high-cost debt with fresh ones raised at much lower rates.

A REMARKABLE feature of corporate performance in the last few quarters has been the falling trend in interest costs. Companies seem to be benefiting from the soft interest rate regime tremendously as they go about substituting existing high-cost debt with fresh ones raised at much lower rates.

A study of the June-September 2003 performance of 850 manufacturing and trading companies, big and small, shows that these companies have pared interest costs by an impressive 21 per cent quarter-on-quarter. As many as 350 of these or 41 per cent of the sample, succeeded in paring interest charges by more than 20 per cent. These include companies such as Tata Motors, Ashok Leyland, Tata Chemicals, Sundram Fasteners, Chennai Petroleum Corporation, Ranbaxy Labs, Indian Rayon, ITC and all the public sector oil companies.

As many as 324 corporates or 39 per cent of the sample saw a rise in their interest costs with the prominent ones among them being two-wheeler companies, Hero Honda (up 57 per cent), TVS Motor (59 per cent), Bajaj Auto, Balrampur Chini and Bombay Dyeing.

How they did it

Those that managed to control interest costs, did so in two ways. First, by substituting debt contracted at rates as high as 12-15 per cent, with low cost debt at sub-5 per cent levels. For instance, Ashok Leyland substituted Rs 80 crore debt in the first half of this year. It raised a $10 million (approximately Rs 46 crore) FCNR(B) loan at a low rate of less than 5 per cent including hedging costs.

Similarly, Tata Motors raised $100 million (approximately Rs 460 crore) during the second quarter through foreign currency convertible bonds at a piffling 1 per cent per annum interest rate in the international markets. It used the money to retire Rs 210 crore of expensive debt on its books.

Second, companies tightened their working capital cycles due to which they did not have to depend on cash credit loans or short term arrangements with banks. With businesses picking up across sectors, companies also found themselves generating cash in healthy doses and hence depended less on banks for financing working capital. This ensured that there would be minimal or even nil outgo on interest to finance working capital.

It is thanks to these efforts and the resultant favourable impact on interest costs that the growth in profits at the net level has been substantially higher than at the operating level for most companies. For instance, in the sample under review, the growth at the net profit level was 32 per cent compared to 10 per cent at the operating level. While a part of this could have been due to lower depreciation in the case of some companies or lower tax outgo for some others, the bulk of the growth appears to have come from the savings in interest costs.

Best may be behind us

So, does this mean that this trend will continue given the continuation of the soft interest rate regime itself? It may really not beyond the near term, maybe till the next couple of quarters. Unless, of course, if interest rates fall further. The fact is that a lot of high-cost debt has already been swapped for lower cost ones by the major names in industry which have also brought the working capital cycle to optimal level.

Of course, there is still much scope for financial restructuring in the case of companies such as Essar Steel and some others but then, they would prove more the exceptions than the rule itself. For the rest, the gains from paring interest costs down the line may not be as spectacular as in the past.

There is also another important factor to consider. Much of the corporate sector is yet to get into the investment mode. It is servicing present demand through capacities built up in the boom period of the mid-1990s. In fact, a number of big companies are only now approaching near capacity levels, which means that they will soon have to get into the investment mode if the present recovery continues.

Once that happens, companies would once again start borrowing from banks and institutions to finance their investments.

That could arrest the possibility of a further paring of interest costs. Yet another trigger for increased borrowing would be higher outlays on promotions and advertisements that will be a natural consequence of competition once consumer demand grows.

But that should not really be a cause for worry because the pay-offs from such investment will cover the incremental interest burden and anyway, revenue growth in a recovering economy would outstrip any increase in expenditure, including interest charges.

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