Firms set for rate change hiccups; stable corporate yields a positive

Yields on 10-year government bonds rose from 6.65% in April 2017 to around 7.50% now

Interest rates have started firming up even as the Reserve Bank of India has indicated that it favours a long pause. Interestingly though, the corporate sector seemed to be set for handling the pressure much better this time compared to what it had done in the past.

Always the first to be affected by any rate change cycle, retail loans, mainly home loans, have started heading north. All other loan rates are likely to witness an uptick. Lenders have also started hiking deposit rates.

According to the marginal cost-based lending rate (MCLR) mechanism, banks have to consider the rise in the incremental cost of borrowing, including from the market. Now bond yields have started rising in the absence of enough liquidity. Higher yields feed into the calculation of lending rates.

Yields on 10-year government bonds rose from 6.65 per cent in April 2017 to around 7.50 per cent now.

Liquidity pressures have increased the cost of funds for housing finance companies. “In the past four-five months, yield curves have moved up by 40-50 basis points and it is time we corrected our rates,” said Sanjaya Gupta, managing director, PNB Housing Finance.

AAA-rated bond yields have moved up to 8.2 per cent from 7.9 per cent in April 2017, according to the data of the Fixed Income Money Market and Derivatives Association of India. Similarly, AA-rated bonds, which cover most of the major companies in India, have inched up only 10 basis points to 8.7 per cent. In case of BBB and below-rated companies, which cover 70 per cent of Indian companies, rates have inched up about 40 basis points to 11.6-11.9 per cent.

However, the rise in gilts has hit state governments. Yields have hardened in line with government bonds and recent auctions showed states paid an average of 7.8 per cent for the 10-year bond when the gilt was trading at 7.16 per cent. Yields are likely to harden by the next auction since gilt yields have moved up sharply in a week. 

One of the reasons for the rise in yields is rising crude oil prices, but according to SBI group Chief Economist Soumya Kanti Ghosh, “oil is now thought to be less of an independent driver of business cycles than earlier.” One reason for stable corporate yields could be the falling number of corporate bonds. Besides, foreign investors have built up a huge interest in India’s corporate debt paper, enabling firms to raise funds relatively cheap. Of the Rs 2.67 trillion allocated as corporate bonds, foreign investors have exhausted 81 per cent. At one point, the utilisation was over 95 per cent.

In 2017-18, the corporate sector raised Rs 5.34 trillion through private placement, against Rs 6.40 trillion in 2016-17, according to the Securities and Exchange Board of India (Sebi). Most of the fund-raising happens through private placements. Typically, 70 per cent of the money raised through corporate debts belong to non-banking finance companies.

Since January 2015, the RBI has brought down its policy repo rate by 200 basis points. In response, banks lowered their retail lending rates by 160-170 basis points. But banks refrained from giving rate benefit to corporate clients. The transmission was not more than one percentage point. Even with the introduction of the MCLR, the transmission has not improved.

Loans to firms depend on a variety of factors such as the rating of the firm, the project for which the loan is taken, and the business environment. So corporate loan rates move in a relatively narrow band.

With credit growth at 11.1 per cent year-on-year, from about 5 per cent a year ago, banks are now in a better position to raise rates.

"Credit growth has started to pick up, and this raises the pricing power of banks. This trend is visible in the past four-five months and has led to banks increasing their MCLR," said Udit Kariwala, associate director, financial institutions, India Ratings & Research. "Banks do not always increase rates after their cost of funds goes up since that would affect margins. Most banks have a large deposit base and raise deposit rates after raising lending rates," Kariwala said.

Housing Development Financial Corp (HDFC), PNB Housing Finance and Indiabulls Housing Finance have raised their home loan rates by 20-25 basis points.

While players like Indiabulls Housing Finance offer home loans starting at 8.45 per cent, State Bank of India’s home loan rates are between 8.35 per cent to 8.9 per cent and ICICI Bank’s ranges from 8.45 per cent to 10.2 per cent.

“We are a pass-through vehicle, we pass our market borrowing cost onto customers, said Ashwini Kumar Hooda, deputy managing director at Indiabulls Housing Finance.  The company said hardening of yields severely affected their costs of funds since they mainly borrowed from the bond market.