Inflation is making Indian companies borrow more – that's bad news when interest rates are high

• Inflation is hitting companies hard, who have been forced to borrow more.
• Worse yet, their borrowings are towards funding working capital requirements, not capex.
• Highly leveraged companies will face tough headwinds in the continuing high-interest rate regime.

Inflation has shaken up economies all over the world, regardless of their development status. The resultant interest rate hikes are burdening the balance sheets of a majority of Indian companies and affecting their capital expenditure plans.

The interest rates were increased for the first time since 2018, ending an era of low interest rates, and upending the business models of many companies.

Inflation has been above Reserve Bank of India’s (RBI) tolerance level for five months straight – the CPI inflation in May was 7.04%, 75% above RBI’s medium-term target of 4%. This forced the central bank to raise interest rates twice in a month, from 4% to 4.9%.

As a result, banks and financial institutions immediately announced hikes in interest rates, increasing the borrowing costs for everyone. Yet, credit has grown multifold across segments.

Source: CareEdge, May 2022

Working Capital takes precedence

Worse yet, companies are borrowing to meet their working capital requirements, not capex. Essentially, this means that companies are finding it difficult to even get by, forget investing in their future and growth.

Working capital loans are usually short-term and attract a higher rate of interest than long-term borrowings. In a high-interest-rate regime – such as the one we are in now – this can prove to be a disaster if the cash crunch continues.

According to a report by CareEdge, bank credit grew by ₹14.1 lakh crore over the last 12 months.

“The growth was driven by a low-base effect, small-ticket loans, an increase in working capital loans due to higher inflation and shift to bank borrowings on account of rising bond yields,” the report stated.

The outstanding liquidity surplus dropped from ₹4.3 lakh crore to ₹3.3 lakh crore – that is a decline of ₹1 lakh crore in just two weeks, from June 3 to June 17. This is a direct result of RBI’s hike in interest rates to tame inflation, but for companies surviving on working capital loans, this only makes matters worse.

High-debt companies to face growing headwinds

While there are plenty of companies in India with no or low debt – some examples include giants like Maruti Suzuki and TVS Motor, apart from Bayer Cropscience and Bharat Electronics, among others – most of the prominent business houses of India have taken on a considerable amount of debt.


Source: Company reports, as at March 2022

In a high-interest-rate regime, finance costs become a bigger part of expenses, leaving lesser cash for companies to fund their operations. It also discourages companies from borrowing more and the propensity of using credit to fund capex reduces, as companies look at shorter-term needs to try and minimize costs.
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