Rate hike may not impact India Inc's earnings

There will be no significant impact on corporate earnings even if interest rates went up by 250 bps over the next two years, according to a sensitivity analysis done by domestic broking firm Motilal Oswal.

A 200 bps hike in interest rates in the current financial year followed by a 50 bps rise in FY 08, resulting in an increase in interest cost by 32 per cent and 36 per cent, respectively, the study said.

This would impede corporate earnings by 3.7 per cent in the current year and an even lower 2.8 per cent in the next year. The study took into account 107 companies forming the universe of stocks tracked by Motilal Oswal.

The main reason for limited impact is the reduction in overall interest expenses over the past few years. For instance, interest rate as a percentage of earnings before interest & tax (EBIT) is down from 44 per cent in FY 01 to 12 per cent in FY 06.

Similarly, interest as percentage of net profit is down from 58 per cent in FY 01 to 14 per cent in FY 06. "Thus, the direct impact of higher interest rates on corporate earnings would be negligible though the indirect impact would depend on the revenue growth for interest rate sensitive sectors," said an analyst at Motilal Oswal.

"The sensitivity of corporate earnings to higher interest rates has declined after the debt restructuring exercises undertaken by companies over the past few years, which has substantially reduced the leverage in balance sheets," said K N Sivasubramanian, senior portfolio manager, Franklin Templeton.

Rising interest rates have become a key worry for investors. Apart from the effect the rise in global rates would have on foreign fund flows, there were concerns about the impact on corporate earnings, consumer spending and stock valuation.

However, the market now seems to be taking the rate rise in its stride. Though volumes have been slipping, partly also attributed to rains in Mumbai, affecting trading volumes, the market is trending upwards.