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Podcast: The Stubborn Cost of Capital in India (Episode 3)



The startup crowd, from Flipkart to Swiggy to Paytm, are all owned by funds from China, Japan or the US. And now, other large companies too are seeing increasing foreign ownership – from an ICICI Bank to HDFC to even the now beleagured Jet Airways by Etihad. Liquor brands in India also – McDowell/United Spirits is now owned by Diageo, Kingfisher beer by Heineken, and so on. The large standout is still Reliance Industries, but by and large, foreign investors find India a lot more attractive than Indians do, it seems.

Why is that?

Shray Chandra and Deepak Shenoy explore the space – high interest rates have raised the cost of capital in India, to a point where it’s actually hurting business growth. After all, if you can get “safe” returns that are 5% more than inflation, why would you bother taking risks?

Deepak discusses a key aspect as well – easing up debt flows from outside India simply because the cost of capital outside India is much much lower. That, and so much more, at The Capitalmind Podcast.

Why is inflation so low but other interest rates so high?
– Headline inflation prints at 2%
– Core inflation (Non food, non fuel) rates are higher at nearly 5% but this is unambiguously trending lower
– Interest rates high because of fear of inflation, fear of NPAs
– This results in the Cost of Capital for the Indian entrepreneur being very high

What does a high cost of capital do?
– Price at which I can sell goods trends up at say inflation of 2%
– Cost of components also trends up with inflation of 2%
– But the cost of capital (working capital) is 8%
– Return of equity could be in single digits
– Why not just invest in low risk debt (8%) instead of taking the effort of running a business?
– High cost of capital hurts current businesses and prevents new businesses from being formed
– If risk free rates are this much higher than inflation, as a saver my capital keeps growing in real terms without taking on risk
– If risk free rate are closer to inflation, people have to take risks with say equity or investing in a business
–  Swiggy, Ola etc. have been beneficiaries or easy money in the US
– India seems at odds with Brazil and Russia on the real interest rates

Why do we pay so much for money?
– Fear of inflation
– RBI feels the inflation drops are transient and not structural
– Horrible interest rate transmission in India. RBI lends to banks. Banks lend to customers. Banks won’t pass on interest rate reductions.
– Banks claim fixed deposits keep their costs high, but have an OIS route to swap out fixed deposits into floating liabilities
– Banks has 30-40% CASA (current and savings accounts) where their borrowing rates are much lower (0% for current and 4% for savings)
– Banks are the primarily lenders for everyone – including NBFCs
– NBFC are back to borrowing from banks (instead of commercial paper) because of the ILFS crisis aftermath
– Government post office deposit rates are high (8.5%) which is competition for banks
– When banks cut rates on RBI urging in 2013, but government schemes (PPF, NPS, Savings schemes) remained at high interest rates and took in massive inflows at the expense of banks
– Biggest government budget item (70% larger than defence) is interest payments on bonds issued.

Why else would the government keep interest rates high?
– Helps savers, retired folk etc.
– But should we hold growth hostage to this?
– Young entrepreneur suffers because they can’t borrow @ 7,8 – 12%
– Far more people dependent on credit than savings
– Business loan (18%) could be more expensive than a personal loan (16%)

How else does this manifest in the real world?
– Hurts Indian entrepreneurs
– Indian companies can’t bid on assets because of high cost of capital
– Road assets are bid on by say foreign investors because of their lower costs of capital and returns are still respectable despite currency risk from inflation
– Rupee since 2000 has fallen 3.5-4% p.a which was the same as the inflation differential, it just happens every few years instead of regularly
– The inflation differential is now much lower at 1% with US
– Significant real return for anyone who can borrow abroad and bring to India
– Indian companies borrowing abroad used to be required to hedge
– Indian investor would rather hold a fixed deposit in a bank than a project like a road
– High interest rates can cause projects to become NPAs in the first place
– Hurts job creation, new entrepreneurship
– People from abroad see opportunity, Indians would rather put funds in fixed deposits or maybe even abroad

Any pitch to the powers that be?
– Government would like to protect savers, perhaps could be achieved with special senior citizen rates like we’ve already started
– RBI – are you data based or not? If the data goes the other way don’t make up reasons to keep rates high. Focus on the data and respond to it
– SME credit is a problem, big companies that could deleverage can take advantage of the current situation but SMES are struggling
– RBI created TREDS for factoring invoices but this hasn’t been popularised.
– Companies now have to take 25% of incremental borrowings from the bond market which could be lower interest rate than banks. Example: Reliance can borrow at 6.5%.
– RBI and SEBI can reduce restrictions on foreign investors investing  at low rates. Let credit in India flow from abroad
– As an entrepreneur, rather take a cheaper loan than give up equity for cheap

Parting note for listeners and customers
– Long term fixed income returns will fall
– Long term bonds will benefit more from a reduction in rates
– Companies that have deleveraged over the past few years and Companies on the brink (say can pay interest rates but not principal right now) will benefit as well

Do let us know your feedback, at @deepakshenoy on twitter, or at podcast [at]