After holding back rates for quite some time, the Reserve Bank of India finally slashed repo rates by 0.5% this week. In response to the big cut, banks such as State Bank of India and Axis Bank have lowered their base rates. And more banks are likely to follow suit. This move is likely to boost demand for small retail loans such as auto loan, consumer durable loan or personal loan ahead of the festive season. However, credit off take by the corporate sector is not expected to revive immediately. This is because the structural challenges faced by India Inc remain.
Among them the biggest problem is that of high debt levels. As per RBI's Financial Stability Report, 70% of a total of 4,388 non-government non-financial companies had a solvency ratio of less than 100% in FY15. Resultantly, the solvency ratio of the corporate sector stands at a mere 26%. Therefore a cut in interest rates cannot boost investments by companies already burdened with debt. At best, lower rates can help ease off pressure of debt servicing for them.
The capacity utilization of the power and cement sectors remain at sub-optimal levels. While the poor health of State Electricity Boards has lowered demand for power, the overall recession has adversely impacted cement demand in the country. To add to this, large infrastructure projects financed by the government have not picked up. Therefore demand for long term project financing by the corporate sector continues to remain sluggish. Additionally, the demand for working capital loans is also depressed due to the overall fall in commodity prices.
Therefore credit off take and asset quality, two of biggest problems faced by public sector banks are unlikely to improve in a hurry. So their fundamentals are also not likely to improve anytime soon. In other words, the rate cut needs to be complemented by continuing policy implementation and structural reforms by the government. This will act as an impetus for growth and investments and spur credit offtake in the long run.
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