CPS MAY BE BETTER FOR COS THAN BANK FUNDS

The base rate mechanism, which now replaces the benchmark prime-lending rate (BPLR) system, is likely to make working capital borrowing from banks more expensive for corporates compared to raising funds from the capital markets.

As per a Crisil study of the working capital requirements of India’s corporates, switching to commercial papers (CP) can save around Rs 1,170 crore in interest costs, thereby resulting in a one percentage point increase in their profits.

The supply of CPs from corporates was low in the past; corporates had the flexibility to avail of funds from banks at rates that were on par with CP rates under the erstwhile BPLR regime. Now, with that flexibility no longer available under the base-rate mechanism, corporates are likely to issue a larger quantum of CPs.

“Crisil’s analysis reveals that corporates with ratings of ‘P1’ or higher, have rupee-denominated working capital bank borrowings of around Rs 180,000 crore as on March 31, 2010, all of which potentially can be replaced by CPs,” the rating agency said in a statement.

According to the rating agency, short-term instruments displayed robust credit quality over the past decade; the one-year default rate for such ratings during 2000-2009 has been zero.

“The additional comfort of liquidity backup, combined with historically robust credit quality, makes CPs rated ‘P1+’ and ‘P1’ by Crisil attractive investment options for mutual funds (MFs), even on a risk-adjusted basis. Under the base-rate regime, MFs can consider lending to corporates directly by subscribing to CPs. Banks, too, are likely to invest aggressively in CPs to retain corporate customers, thereby adding to the overall demand for CPs,” said Raman Uberoi, senior director of Crisil Ratings.

“By making this switch, the rating agency estimates that corporates can save as much as Rs 1,170 crore in interest expenses — equivalent to around 1% of their net profits. These savings may be higher during periods of abundant liquidity,” said Somasekhar Vemuri, head of Crisil Ratings.

Source: http://economictimes.indiatimes.com/news/news-by-industry/banking/finance/finance/CPs-may-be-better-for-cos-than-bank-funds/articleshow/6249826.cms