In a significant shift that reverberated across global financial markets, the Bank of Japan (BOJ) recently ended its eight-year experiment with negative interest rates. On March 19, 2024, the BOJ raised its benchmark rate to a range of 0-0.1%, marking the first rate hike in 17 years. This move, while seemingly modest, carries profound implications for economies worldwide, including India.
For Indian companies, particularly those reliant on foreign capital or engaged in international trade, this shift presents both challenges and opportunities that warrant careful consideration. The Ripple Effect on Capital Availability and Cost: Japan has long been a significant source of global liquidity, with its investors seeking higher yields abroad due to ultra-low domestic rates. The move to positive rates, even if minimal, is likely to trigger a gradual repatriation of Japanese capital.
For Indian companies, this potential shift in capital flows could manifest in several ways:
Reduced Foreign Investment – Japanese investors, who have been substantial players in India’s equity and debt markets, are recalibrating their portfolios. With domestic Japanese investments becoming more attractive, there will be some slowdown in foreign direct investment (FDI) and foreign portfolio investment (FPI) from Japan into Indian companies.
Higher Borrowing Costs – Indian corporations that have tapped into the Japanese market for low-cost loans or issued yen-denominated bonds (Samurai bonds) are likely to face higher refinancing costs. The yield curve for Japanese government bonds has already flattened (i.e., the difference in interest rates between short-term and long-term bonds has decreased). Typically, long-term bonds offer higher interest rates than short-term ones to compensate investors for tying up their money for longer periods. However, in Japan’s case, this difference has shrunk. When the yield curve is steeper (bigger difference between short-term and long-term rates), banks can make more profit by borrowing short-term at low rates and lending long-term at higher rates. This often encourages them to seek higher returns overseas. With a flatter yield curve, the potential profit margin from this kind of lending strategy shrinks. This makes it less financially attractive for Japanese banks to lend money to foreign entities, including Indian companies. As a result, Indian companies that have been relying on external commercial borrowings (ECBs) from Japanese banks might find it harder to secure new loans or might face higher interest rates on future borrowings.
Pressure on Rupee-Yen Exchange Rate and Importers – Any significant repatriation of Japanese funds is also likely to put pressure on the rupee-yen exchange rate. When Japanese investors start moving their money back to Japan, they’ll need to sell rupees and buy yen. This increased demand for yen and selling of rupees can cause the yen to appreciate against the rupee. Thus, Indian companies that import goods or services from Japan will face higher costs. This is likely to lead to increased production costs and potentially higher prices for Indian consumers. Importers may need to renegotiate contracts or find alternative suppliers to manage costs. Specifically, we believe industries reliant on Japanese technology or machinery imports might face cost pressures. The automotive sector (Maruti Suzuki, Toyota Kirloskar Motor, Honda Cars India) has significant exposure due to joint ventures, technology partnerships, and import of components from Japan. Many Indian electronics and consumer durables companies (Videocon, Havells, Blue Star) and Indian steel and heavy engineering companies (Tata Steel, JSW Steel, Larsen & Toubro) also import components or finished products from Japan and have exposure. Increased Competition for Exporters – Initially, Indian exporters to Japan might benefit as their goods become relatively cheaper for Japanese buyers. However, this advantage could be short-lived if competitors from other countries also experience currency depreciation against the yen. Long-term contracts priced in yen could become less profitable for Indian exporters if the rupee continues to weaken. Some Indian pharmaceutical companies (Sun Pharma, Dr Reddy’s, Lupin) importing APIs (Active Pharmaceutical Ingredients) and Indian IT services companies (TCS, Infosys, HCL Technologies, Tech Mahindra) having significant exports to Japan might need to adjust the pricing of their goods and services contracts respectively to maintain export revenues.
Sectoral Impact and Opportunities
The impact of Japan’s policy shift is also likely to vary across different sectors of the Indian economy:
1. Infrastructure and Manufacturing – These sectors, which have benefited from Japanese investments and technology transfers, might face challenges in securing new investments or renewing existing partnerships on favourable terms.
2. Automotive Sector – The Indo-Japanese collaboration in the automotive sector has been very strong for a very long time. Any changes in investment patterns or cost of capital could affect joint ventures and technology-sharing agreements.
3. Renewable Energy – This sector has seen substantial Japanese investment. While long-term projects may not see immediate impacts, we believe future funding for new projects might become more competitive.
4. Start-ups and Tech Companies – Indian start-ups that have attracted Japanese venture capital might need to diversify their funding sources if Japanese investors become more domestically focused.
Strategies for Indian Companies to Mitigate Risks and Lower Costs
In light of these challenges, Indian companies can adopt several strategies to mitigate the negative impact of Japan’s interest rate policy move:
1. Diversify Funding Sources – Reduce dependence on any single geographical source of capital and explore alternative markets like the Middle East or Southeast Asia.
2. Enhance Operational Efficiency Through Technology – Focus on improving productivity to offset potential increases in capital costs by investing in digital transformation and automation.
3. Explore Local Partnerships – Strengthen strategic partnerships with Japanese firms operating in India to potentially access capital through joint ventures.
4. Green Financing – Explore green bonds and sustainability-linked loans, which often come with preferential terms and attract a diverse investor base.
To sum it up, while Japanese rates are still low by global standards, there is expected to be increased competition for capital. As global investors reassess their portfolios, Indian companies might face stiffer competition for capital from other emerging markets.
Companies that have built business models around cheap foreign capital might see pressure on their margins. With potentially reduced Japanese investment, some sectors might see a slowdown in mergers and acquisitions activity. Due to the interconnectedness of the global economy, if the shift in Japanese policy contributes to an economic slowdown, Indian companies could face reduced demand. While our immediate focus might be on challenges, Japan’s policy shift also presents opportunities for Indian companies.
As Japan looks to diversify its supply chains and investment destinations, India’s growing economy and large market present attractive opportunities for deeper economic ties. Indian companies with strong balance sheets could explore acquisitions of Japanese assets or technologies that might become available as Japanese firms restructure. With both countries committed to sustainability goals, there’s potential for increased collaboration in green technologies. As Japan grapples with an ageing population and potential labor shortages, opportunities for Indian IT and healthcare services exports could expand.
Disclaimer: Views are personal and carry no affiliation to any institute.
