Mumbai: Rising interest rates and a growing dependance on debt have started taking a toll on the profitability of Indian firms.

A Mint analysis of 1,742 listed firms, for which data is available, shows that interest costs have almost doubled in the past one year, denting their profitability.

In absolute terms, the interest costs of these firms rose to Rs16,383.56 crore in the second quarter of this fiscal, up fr-om Rs8,201.83 crore in the corresponding period last fiscal.

During this period, the aggregate net profit of these firms has come down by close to 29%—from Rs55,150.48 crore to Rs39,165.84 crore.

The analysis excludes banks and financial institutions because they are in the business of borrowing and lending money.

Also See The Rate Effect (PDF)

Some analysts and a few chief financial officers of Indian firms expect the interest burden to come down following recent cuts in the prime lending rates—or the rate at which a bank lends to its most creditworthy customers—by public sector banks, but cauti-on that it might take at least six months before this has any significant impact on net profit.

The interest coverage ratio, or the number of times a company can pay interest from its available earnings, for these companies has slipped to 4.27 for the quarter ended September from 10.33 in the corresponding quarter of 2007-08, reflecting the impact of new debt taken on and higher rates.

The ratio is calculated by dividing a firm’s earnings before interest and taxes, or EBIT, by interest paid. In other words, the aggregate EBIT of these firms was more than 10 times their interest burden a year ago and has now come down to a little more than four times.

The interest coverage ratio for the firms reviewed has consistently declined over the past six quarters for two reasons— rising interest costs as well as lower EBIT on account of a decline in earnings due to a combination of falling demand and higher input costs. A higher exposure to debt contributed to a correspondingly higher interest burden. Many firms borrowed because they wanted to take advantage of low interest rates and use debt to finance their expansion and acquisition plans. They started feeling the pinch when interest rate started rising—a result of efforts by the Reserve Bank of India (RBI) to rein in inflation earlier this year.

An interest coverage ratio of less than 1 means the firm is not making enough gross profit to service its debt. In the September quarter of this fiscal, the number of firms for whom this ratio slipped below 1 stood at 320, almost one-fifth of the sample.

To be sure, for the 30 firms that constitute the Sensex, the benchmark index of the Bombay Stock Exchange, the interest coverage ratio is still at 9.32 for the quarter ended September, indicating that these firms have cash and are not hugely dependant on borrowings. However, even for these firms, the ratio was 21.73 in the corresponding quarter a year ago.

Even real estate firms that depend significantly on borrowings from banks have an interest coverage ratio of 5.54 in the September quarter, lower than that of the Sensex firms but higher than the average interest coverage ratio of the larger sample.

“In a manner of speaking, we have seen the worst. Once debt levels (of firms) stabilize, there is room for improvement as we see some easing on interest rates, going forward," said Nitin Khandkar, vice-president, research, of Mumbai-based brokerage Keynote Capital Ltd. “But it will take one or two quarters for the effects to show. We will see some impact in the last quarter of this fiscal, but any substantial impact only in FY10."

RBI raised its policy rate by 150 basis points between January 2007 and July 2008 to 9% in an effort to rein in inflation, which spiked to a 16-year high of 12.91% in August 2008. One basis point is one-hundredth of a percentage point.

A global liquidity crisis in the wake of the collapse of Wall Street icon Lehman Bro-thers Holdings Inc. in September hit India, too, and banks raised their lending rates aggressively in past two months. They were also not comfortable in lending to all corporations when liquidity tightened.

RBI has since cut its policy rate by 150 basis points; the cash reserve ratio (CRR), which determines the amount of reserves banks have to deposit with the regulator, by 350 basis points; and statutory liquidity ratio (SLR), or the portion of deposits which banks have to invest in government bonds, by 100 basis points, to ease the liquidity crunch. Even that did not prompt banks to cut lending rates till they met the finance minister this week. Subsequently, most state-owned banks have cut rates.

“It will take two-three months before banks get into the groove," and start lending, said Prabal Bannerjee, group CFO of the Hinduja Group.

According to M.V.S. Seshagiri Rao, director, finance at JSW Steel Ltd, India’s third largest steel maker, interest rates on working capital loans have gone up. “The only option is to reduce the level of inventory" to combat spiralling interest costs, he said.

“We believe that the rates are coming down, but benefits may not come immediately."