Download Commercial paper may not be economical for big companies

Commercial paper may not be economical for big companies
Anup Roy, Mint, Friday, New Delhi, July 16, 2010 3:55 AM
A fortnight after the base rate replaced the benchmark prime lending rate (BPLR), rates in the
commercial paper (CP) market have belied expectations that they would be a cheaper route to
short-term funding for large corporations.
Yield on the three-month commercial paper for the highest rated firms is 6.75%, marginally below
the base rate, or the minimum rate at which a bank can give loans. The base rates of foreign,
private and public sector banks range between 7% and 8.25%. The rates for the three-month
commercial paper was as low as 4.6% in May.
A commercial paper is a short-term promissory note issued by a firm for working capital needs.
The papers are discounted to their face value.
After the Indian banking system moved to the base rate regime beginning 1 July, the possibility of
a well-rated firm raising short-term loans at low rates was effectively eliminated as lenders were
prohibited from giving loans below their base rates.
Firms that in the past could raise short-term loans at rates as low as 6% will likely move to the
commercial paper markets for short-term loans, say industry experts. Bankers, for their part, say
they will encourage such movement and will participate in such issuances.
However, if short-term rates are any indication, companies may not find it very economical to
come into the CP market, at least at this point in time.
Besides a 6.75% coupon, a firm will have to pay another 0.10-0.15% by way of stamp duty, rating
expenses and other administrative costs.
"At these levels, the interest rates at commercial papers market are prohibitively costly for
companies," said Hitesh Shah, vice-president of A.K. Capital Ltd, a bond brokerage.
According to Shah, top-notch companies are able to raise short-term loans at 6.75-7% in this
market. "I have not seen many companies rushing to the CP market in the last 15 days," he said.
However, R.V.S. Sridhar, head of treasury at Axis Bank Ltd, said firms will have to come to the
banks even if the CP route is open. "Raising fund from the CP market is a one-off act and is
subject to uncertainties in the market," he said.
To be sure, the gradual rise in interest rates in the CP market since May is because of tight
liquidity.
Banks are, on average, borrowing more than Rs40,000 crore a day from the central bank after
payments for third generation, or 3G, telecommunication spectrum and advance tax payments
drained liquidity from the system.
Going forward, economists expect interest rates to tighten by at least another percentage point by
December, which will push lending rates of banks higher. Shah, along with bankers, said the
situation will likely loosen a bit in about two months when liquidity eases.
Goldman Sachs , however, said in its 15 July Asia Economics Analyst report, that liquidity is
unlikely to improve in the near term.
"The market appears to view this (tightness in liquidity and the resultant shift in the short-term
policy rate) as temporary, induced by the outflows due to the 3G telecom auctions. Therefore,
short-term policy rates are expected to fall once liquidity flows back into the system. We think
not," said the report, written by Tushar Poddar, India economist at the investment bank.
An analysis by Goldman Sachs shows that banks may not be able to raise deposits at a
substantially higher level than the present 14%, which is lower than the target of 18% set by
Reserve Bank of India (RBI).
However, credit growth will continue to outpace deposit growth, straining resources. The analysis
points to "broad money growth for FY11 (fiscal 2011) at 15.1%, much lower than RBI's projection
of 17%."
Even if commercial paper rates get some respite from an easing in the liquidity situation, the hike
in interest rates will still make them expensive.
Companies, though, say that in the base rate regime, they have to come to the commercial paper
market for short-term needs.
"If a company is able to raise short-term papers at 6.75% from the market, the same company or
similar rated ones won't be able to get loans from banks at less than 8%," said Prabal Banerjee,
group chief financial officer of Hinduja Group. "So (the) CP market will always be there for the
companies in this base rate regime," he added.
"For working capital needs, companies need continuous flow of funds that they can roll over
every three month or so," said Sridhar of Axis Bank.