Increasing interest rates could deliver rude shock for corporates with higher borrowings

• Firms with high gearing could see their earnings tighten and could even report losses 
• Analysts point out unwinding monetary policy support could cause severe damage unless done carefully and in a gradual manner

A number of Sri Lankan corporates could be in for a rude shock with the reversal of the direction of interest rates in the market, according to analysts.

As Sri Lanka’s borrowing costs declined to all-time low levels during the pandemic, corporates went on a borrowing binge piling up a significant amount of debt and bonds in their balance sheets to both refinance their existing loans as well as to expand operations. 

But the interest rates have now bottomed out and are expected to rise faster with the Central Bank tightening its monetary policy. The increasing interest rates in the economy are clearly reflected in the rising 
bond yields. 

“In fact, this is the elephant in the room, which no one is still talking about,” said a chief financial officer of a leading diversified conglomerate on condition of anonymity. 

“We are currently analysing the impact and how deep it (rising interest rates) could penetrate affecting our profits and balance sheet structure,” he added.

At the same times, banks appear to be visibly worried about the impact the rising interest rates will have on their non-performing loans, as years long pandemic time moratoria are coming to an end.

This may be why the Central Bank’s return to neutrality and the tightening cycle thereafter must happen gradually without causing an economic hard landing and a potential recession, as opposed to some economists who call for a sharp increase in rates, as they aren’t responsible for the second order effects of such actions. 

Sri Lankan corporates added debt at a record pace in the last two and half years, taking advantage of the historically low interest rates, as the pandemic-induced lockdowns prompted the Central Bank to cut rates to rock bottom levels. 

Lower interest rates and the Central Bank liquidity helped these corporates to stay afloat, refinance the existing loans at lower rates, prevent mass scale layoffs and fund expansion projects, without which there would have been market carnage.  

However, a faction of economists and analysts believe that cheap money made available by the Central Bank through lower interest rates and money printing have resulted in the soaring inflation and currency troubles the country is suffering from at the moment.