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The Impact of Interest Rates On Equity Markets

Every bank adheres to the interest rate set by the central bank, in its country. The central bank in India is the RBI that decides the interest rate, which other banks have to abide by. In case of shortage of funds, banks borrow funds from the RBI, and the money is lent at the repo rate that is then deemed as the benchmark rate. Hence, every increase and the decrease in the repo rate have its repercussions on the life of a common man. An increase in repo rate will make it difficult for banks to borrow from RBI, resulting in an increase in the cost of fund, and vice- versa.

The quarterly review of monetary policy by RBI on 29th January 2013, will hence hold a lot of significance. A survey conducted by the Economic Times involving 10 economists suggests that the repo rate could fall by 0.25% to 7.75%. The equity market, thus, has to keep a close watch on the same, considering its huge dependence on the interest rate.

 

The following few factors will explicate the negative impact of high interest rate on the equity market:

 

1. High interest rate eats into the company’s profit

The continuous increase in the rate of interest has reduced the net profit as a percentage of sales, over the years. Complying with the monthly bulletin for January 2012-13, companies across domains and sectors had to pay 3.7% of their sales as interest vis-à-vis 1.6 %, four years ago. Consequently, the net profit as a percentage of sales has plunged to 6.4% in the first half of 2012- 2013, in comparison to 9.2%, four years back.

 

2. Small Companies have to bear the brunt of it

A study by RBI that catered to small, medium, and large companies put into light the fact that small companies were the major sufferers of high interest rates. It was observed that the interest rate that is paid as a percentage of sale was 9.2% for small companies’ vis-à-vis 5.8% for medium sized companies and 3.3 % for large companies, standing as a testament to the fact that banks charge smaller companies more than others.

Based on RBI’s segmentation, smaller companies were ones having sales of less than Rs. 100 crore whereas the medium sized ones reported sales in the range of Rs.100 crore to Rs.1000 crore. On the other hand, large sized companies had sales accounting to more than Rs. 1000 crore.

 

3. Share market feels the heat

Investors tend to shift their preference from the stock market to fixed deposits or fixed return assets, whenever interest rates mount, to make the most of it. The year 2012, hence, witnessed a number of Indian investors divesting money from the equity market. The Security and Exchange Board of India also claimed that mutual funds, during January 2013, were in full swing with net sellers accounting to Rs.2770 crore. On the other hand, foreign investors including the USA chose to invest in developing countries like India, when the interests were low. FII’s have infused $3 bn in Indian equity market, from January 2013 to the present date. The study also made it evident that investors in India are risk – averse and do not feel the need to bet on share market, if they are availed with alternative safe investment options.

 

4. High Interest rate decelerates growth

High interest rates make it difficult for companies to invest, pay the loans, and embark on expansion plans. The demand for goods and services fall as one chooses to consume less and spend less. Besides hindering the growth of companies, it also cuts down job opportunities, resulting in a slowdown.

 

Reduction in Interest rate will hence serve to be a positive trigger, boosting optimism and intensifying investments.

 

About Kotak Securities:

Kotak Securities is one of India’s share broking firm offering demat accountonline trading, mutual fund and IPO investing service’s along with a research division specializing in Sectoral Research and Company Specific Equity Research.We also provide you with live share market update & insights.

Express your views on their Facebook Page and Twitter Handle (@KotakSecurities) or you can also visit KotakSecurities.com for more information.

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