The rate rise rap

Earnings in several sectors are set to be impacted

With interest rates on their way up, how will India Inc be affected? Which sectors will be affected the most?

The main impact of any increase in interest rate would be on companies who've recently made plans to raise debt. Primary among these would be telecom operators in the wireless space who are expected to expand operations in a big way in the next one year.

Some of these players, namely Hutch, Idea and Reliance Infocomm are expected to raise money through the IPO route. But considering the size of the expansion plans, wireless players will also have to raise debt. Another sector which has large expansion plans is the steel sector, and a big chunk of this will be financed through foreign debt.

For steel companies, though, the problem will be offset by a rise in exports. In the oil and gas sector, GAIL has laid out huge expansion plans for the near future. It's pipeline project is expected to cost approximately Rs 3,500 crore, which is much higher than the company's internal accruals of around Rs 2,000 crore.

The balance, obviously, will have to be raised through debt. Construction companies pursuing private-participation projects are also expected to raise capital, as these projects demand huge capital investment.

But since returns from these projects are back-ended, some companies may use the equity route. Engineering companies, as usual, need to raise debt for their yearly capex requirements, but this will have minimal impact on overall performance, as debt has already been reduced to a large extent lately.

It's also important to realise that the rise in costs may be offset by volume gains, especially since rise in capex spending by India Inc will raise investment demand.

The banking sector is expected to be the worst hit. This is especially true for public sector banks, which in the past couple of years have made much of their profit from treasury gains. Larger banks such as SBI, BoB, and PNB will have a larger impact as their portfolio consists of relatively long duration government bonds.

Banks such as Corporation Bank and OBC will be impacted less since the duration of their bond holdings is lower. Private banks are better placed, since their bonds have a shorter duration, and in some cases like ICICI Bank's, a big chunk of the portfolio is based on floating rates.

Sectors such as cement have already expanded capital, and there are hardly any plans of fresh capacity addition. In the auto sector, most companies are sitting on a reasonable amount of cash. But a hike in interest rates may hit sectors like auto, consumer durables, and housing finance on the demand side.

If the hike in interest rates is marginal at around 100 basis points, the impact may not be much, since this will result in a not-so-significant increase in EMIs. But still, the very fact that instalment payments wouldn't get lower from current levels would deter some first-time buyers.

Sectors such as FMCG, IT and cash rich companies in general will not be impacted by the rise in interest rates.

Good news from fundmen

A couple of weeks ago Merrill Lynch had carried out an informal survey among institutional investors attending their global emerging markets conference in California, and the results are illuminating.

Among countries, the most popular overweight was India, with 48.1 per cent of those polled saying they are currently overweight on India.

The high percentage of investors currently overweight on India would limit the upside and increases the downside risks. However, 53.8 per cent of investors said they would add to their positions in India within one to three months. Russia and South Africa are the markets most likely to see inflows, as 72.7 per cent and 76.9 per cent of the investors said they would add to their positions in these markets.

The silver lining was that 35.3 per cent of those surveyed saying that global emerging market equities would be the best performing asset class by the end of the year. 53.8 per cent said the new Indian government will not make any significant policy shifts, while 30.8 per cent said they weren't sure.

Investors were also uncertain about the impact of US Fed tightening, with 55.2 per cent saying that emerging market equities can weather a 175 basis point rise in the Fed Funds rate by end-2005, while 44.8 per cent said they would suffer from the impact.

BNP Paribas too had concluded that the Indian market had been overbought by foreigners, and indicators like the premium paid on closed-ended funds point to the excesses.

With contributions from Mobis Philipose