Inflation: India Inc feels the sting

Rising interest rates are forcing companies, big and small, to either defer projects, go slow on expansions or raise money from alternative sources.
For instance, Mumbai-based steel-maker JSW has reduced the scope of its steel project in Bengal and has decided to implement the project in phases. In the first phase, it will set up a pellet and coal beneficiation plant (in three years by 2011), which will cost Rs 4,000 crore against Rs 15,000 crore for the entire project.
"In the first phase, we will focus on the raw material side, get the coal linkages to produce pellets and sell them in the market,'' said JSW CFO Seshagiri Rao.
Higher interest rates will also pull down margins on all projects as most term loans, like in home loans, are on floating rates.
Infrastructure developers in road, port, power or airport projects are also feeling the heat of rising rates, especially if these projects are on a build-operate-transfer (BOT) basis and the loan is on variable interest rates.
Take BOT road projects, for which the interest risk lies with the developer. Four months ago, banks were charging 11-12 per cent (higher in the case of a fixed rate loan); now the interest rate has gone up to 14 per cent. "With inflation at 13 per cent, I expect interest rates to go up 1-1.5 percentage points more," said Praveen Sood, CFO, HCC Ltd, a Mumbai-based construction firm.
Consider how interest costs will impact HCC's Badarpur elevated flyover project in Delhi it won four weeks back. The project will cost Rs 550 crore, including an engineering procurement construction (EPC) cost of Rs 494 crore and interest during construction (IDC) of Rs 56 crore. With interest rates going up, not only will the IDC go up but HCC will have to bear higher interest rates on servicing the entire debt of, say, Rs 380 crore.
It won't be able to recover the higher interest costs as the toll on the road project is fixed for the concession period. The EPC cost could go up. As a result, HCC will take a hit on its internal rate of return from 16 to 17 per cent to 13 per cent.
Returns will also be squeezed on several power plants and port projects (like Mundra) that are being set up or operated on a merchant basis.
But not all projects and players will be affected. "It will hurt us marginally if we are exposed on the variable interest rates and cannot pass on the interest rates increases in non-regulated part of the businesses,'' said GVK CFO Isaac George.

GVK will be hurt in a few road and power projects (like 464 mW Gautami Power Project) for which the loans carry variable interest rates. In some other projects, it has fixed the rate on loans at a lower rate for five years or in power projects that are on a cost-plus formula, for which higher costs will be absorbed in a pass-through in tariff. In airports too, higher costs will be passed through in aeronautical revenues.

Smaller companies are equally stretched. Take Mumbai-based Ratnaraj Diamonds, a diamond exporter that started selling solitaires through jewellers. Encouraged by its success at home, it was planning to double production capacity in 2008 and ramp up stock levels 10 to 15 times.

Now, it has decided to scale back its plans. It has deferred buying a new laser-cutting machine which costs Rs 40 lakh to Rs 50 lakh and partially cut the planned increase in its stock levels. Shailen Mehta, the firm's CEO, said his cost of funds has gone up by 3 per cent.

In Delhi, Rajat Tuli and Rahul Anand are having a hard time fighting the slowdown in the market. The young promoters of Happily Unmarried, which sells fun lifestyle gifts, had big plans for 2008. They wanted to triple their sales by doubling the number of products and adding 11 more shops this year.

Against that, they could manage to do just add four shops. The promoters have been relying on personal loans, at 14 to 16 per cent, to fund their business and has just started getting some short-term business loans, but at 18 to 19 per cent. "Given these rates, it doesn't make sense to borrow and grow the business. So, we are selling 5 per cent equity to private investors,'' said Tuli.

Bangalore-based Aron Universal, a manufacturer of fluorescent pigments and inks used in products with fluorescent colours, was planning to triple production and corner a third of the Rs 350-crore market for these niche products.

"With interest rates at 14.75 per cent, we are going slow on our expansion and trying to generate the funds from alternate sources like shareholders or private investors," said CEO Shailesh Patel.

The battle against inflation is clearly hurting corporate India; if interest rates go up further, there could more pain.
http://www.rediff.com/money/2008/aug/19infla.htm