The pain of higher borrowing costs and stretched working capital cycles are yet to show up fully in the financials of corporates, opines Srividhya Rajesh, Fund Manager for top performing funds such as Select Focus and CAPEX Opportunities from the Sundaram BNP Paribas stable.

Excerpts from the interview:

Do you perceive a risk of a prolonged funds crunch locally ?

Specific sectors such as the real estate have been hit by the funds crunch. Based on our own experience and from what we hear, they are borrowing at very high costs Lending costs have alos gone up across the board. Even blue-chip companies are borrowing above 12 per cent. However, it is the cost of money and not the availability of money that is an issue.

As for availability of credit, the lending standards should probably have got stiff by now as the RBI has been tightening the CRR and the rates. However there may be a crunch eventually; there can be crowding out once the Government’s borrowing programme is out for the year.

Is there a more serious problem for the mid- and small-cap companies in terms of banks being reluctant to lend?

Earlier avenues such as the ECBs and FCCBs are short at this point in time. Equity is clearly not there. While some of them have already raised money, there are others who have not tapped the markets, who may face a problem. However, companies can derive comfort if they are sitting on a good quality balance sheet – for instance, we came across a mid-cap IT company that has tied-up funds at 12 per cent. So companies with reasonable liquidity in the balance sheet may not face problem.

So are mid-cap stocks likely to enjoy the valuations they did a year ago or would they see moderation in valuations going forward?

In tight interest rates environment, we have always seen the valuations contract for these companies as access to credit and cheap availability of funds is a key for them since they seldom have a strong balance sheet to support ambitious capex programmes.

The de-rating has happened and is here to stay for sometime. The business environment is also getting tough for them because in a slow down there will be market share losses as competition gets more intense. To that extent the smaller players can get nudged out.

But things may take a turn once interest rates ease — the recent view is that the easing should start in the second quarter of the next calendar year. If commodities remain soft, inflation would probably come down, post 2008. So there can be some kind of environment which gets built up for rates to soften and the economy to be back on track. Mid-caps can then start getting re-rated provided they have not failed expectations in terms of delivering numbers.

Is the pain of increased cost of borrowing already reflected in the financial numbers ?

No, it is still probably early days. We are not seeing it yet, in terms of numbers. While the ‘other income’ had come down considerably in the first quarter, the increase in interest cost and the pain in the balance sheet is yet to show up. We will probably start seeing it from the third quarter of this year.

With the metal prices and other commodity prices going up, the working capital cycle would have gone up. That would have also led to higher interest costs. But that is not fully felt as some of them had forward contracts which should have helped them in the first quarter.

While the effect may be felt to an extent in the second quarter, it is mostly likely that it will be reflected in the numbers in the third quarter.

Even if macro situation improves, do you believe FII inflows – a key for stock market liquidity could quickly bounce back, given the global scenario?

On a YTD basis money pulled out is over $7 billion. This is quite significant compared to last year and the trend appears to be continuing given the pressures that FIIs have at home — be it hedge funds or even long only funds. Further, in this market, the emerging market risk appetite would have certainly come off.

Locally, because of high crude prices, our fiscal situation worsened and that was construed very negatively by the foreigners. So, it is unlikely that the situation will reverse in the current year. Local money flows have still been positive YTD. And that’s stepping in. But many funds are still sitting on the sidelines, holding cash.

Do they prefer to stay on the sidelines until they see FII money coming in?

While global liquidity is a concern, it is the fundamentals that are more worrying. We see earnings deceleration and while we have seen some earnings downgrades happen, a lot of it has still not happened. This is because you don’t get a sense of slowdown happening when you talk to the corporates.

So, to this extent, analysts have also not been very aggressive in cutting down the estimates. Specific sectors where there have been negative news flows have been downgraded. Otherwise, across the board, numbers have not been cut.

But when you scan the ground, you know that there is definitely a slowdown. Take hotels, where occupancies have come down or the slowdown in airlines. So that is something that the funds are anticipating and, hence, not taking positions at this point in time. They would rather see it play out.

Unlike the global funds, which are either in the market or out of it, in India we do not have a mandate of being fully . Here, investors expect you to protect them from downside as well. That is the reason why we have held on to cash.

How does India’s outlook compare with other Asian markets?

I think the question mark is primarily on global growth and how 2009 is going to pan out. The picture that is emerging is that 2009 could be a worse year than 2008. This is because the monetary measures could start impacting us from 2009 onwards, as there will be a lag effect to all the tightening and squeezing of credit that has happened in 2008.

And the global pain is also just being felt. Europe has still not come clean from the sub-prime losses. Japan is going in and out of recession. Asia-Pac is pulling on, but they are to a large extent linked to the US and Europe in terms of trade. Replacing the US consumer will take time. Global growth is a concern in 2009, and more so for India.

The markets are therefore not going to become cheaper because prices have corrected. And when earnings decelerate P/Es also get compressed. Unless India proves to be more resilient in terms of corporate earnings and is able to grow at, say, 7.5 per cent, overseas investors may not be so tempted merely by the valuations having come off.

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