Rate hike to hit profit margins

With close to 30-40 per cent of the small and medium enterprises (SME) funding coming from borrowings, the increase in interest rates is bound to affect SME margins by about 2-3 per cent, note industry experts.

SMEs fear the repeated hike in prime lending rate (PLR) is likely to impact their bottom line. PLR is the rate at which banks extend loans to their most credit worthy customer. In the last one year, the PLR of most banks has increased by over 2 per cent. Cost of borrowing accounts for around 8-10 per cent of the total cost of an SME. As a thumb rule, a 1 per cent increase in interest rates affects 0.33 per cent of a company's turnover.

Yogesh Dixit, head rating SME, Crisil, notes it will be difficult to gauge the effect of the impact as it has just been introduced, but in the long term this will certainly affect SMEs. He further remarked that those into exports might not be as affected as those catering to the domestic market.

Raghav Narsalay, chief economist, Economic Laws Practice, believes for the SMEs this is a double whammy. "This kind of a hike is a hurdle for an SMEs growth from a volume to value-driven companies. They would want to spend more on R&D. But if there is a dearth of funds from the market and no support from the government, this will be difficult to achieve," he says, adding: "Though the rupee has been appreciating, import rates are coming down and this will affect export-intensive units. Companies will look at imports rather than the domestic market. Moreover interest rates are increasing making the working capital costlier."

"The rising interest cost will definitely have an impact on the bottom line. The only way to balance the cost is to resort to foreign currency borrowing. The combination of both foreign and local debt should enable keep the cost of borrowing at single digit,'' said Arun Agarwal chief financial officer, Bhushan Power and Steel.

"Small companies are highly sensitive to interest rates movement. Companies with a turnover of less than Rs 25 crore do not have much negotiating power and they are the higher risk category borrowers,"' said J Chandrasekaran, chief general manager, State Bank of India.

For instance, RSB Transmission, an auto component manufacturing company, has traditionally been depending on borrowing. Out of RSB's expansion plans on an average between 45-50 per cent of fund are raised by borrowings according to Rajnikant Behera, manager-corporate strategy and planning of the company. Though the future expansion plans of RSB continue undeterred, the mode of funding might change. "If still interest rates continue to rise we intend to raise further funds by mix of private equity, FCNRB/ECB," added Behera.

Amol Jain, Director, Lumax Auto Technologies feels that RBIs move has already impacted the two-wheeler segment. He also feels that the company will look at future funding through borrowing more carefully. "The first option will be to raise funds through internal accruals and secondly, what percentage will borrowings be a part of the funding will depend on the interest rates," he adds.

Naval Khanna, director group finance of Lumax feels 2 per cent of their borrowed capital funds will impact the bottom line. As of March 31, 2006, the company had borrowed Rs 45 crore. The company has plans to invest close to Rs 90-100 crore on further expansion of the its infrastructure and technology this financial year. The group is opting for preferential allotment through collaborators to raise Rs 50-60 crore while the rest will be funded through internal accruals.

Kewal Kiran, an apparel manufacturing company is looking at smart borrowings from other sources. "Though we have not been hit by the increase a lot of others companies in the apparel segment have been affected," said Nikesh Jain, chief financial officer, Kewal Kiran.

"Mid-tier companies would have to be proactive in reducing cost of raw material procurement, efficiently manage their distribution cost and improve their manufacturing process. To become competitive and manage cost SMEs would have to pass on the cost to the end user,'' said Asok Kumar, executive director, UTI Bank.

"Corporates can also meet their capital requirement through foreign currency borrowing. However, not all companies can borrow overseas. In the current context, the exchange cost is also very high which cannot be borne by small companies,'' added Kumar. "Alternate exchanges are a good option but remember the rupee has appreciated too. The willingness of these exchanges to loan against a strong rupee is doubtful," corroborates Narsalay.

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THE BIG PICTURE

India has close to 12 million SMEs

They contribute around 6.7 per cent to the GDP

Employ 30 million; second to agriculture

Comprise 35% of exports