Cautious Optimism for Credit in 2026-27, but Rate Relief Remains Elusive: India Ratings

India Ratings and Research today said in a report that it expects interest rates to remain firm in India’s credit markets in 2026–27, weighed down by sustained geopolitical tensions and persistent challenges in bank deposit mobilisation, even as liquidity stays supportive and the broader outlook remains cautiously optimistic. 

The rating agency expcts 2026–27 to be defined by measured optimism rather than a clear easing cycle. The domestic economy continues to show resilience and the Reserve Bank of India maintains a proactive and supportive policy stance, yet heightened geopolitical risks and structural constraints within the banking system are limiting the pace and effectiveness of rate transmission, it said, adding that these factors could quickly shift market sentiment, particularly for weaker credit profiles.

Liquidity Outlook
The Reserve Bank of India is expected to continue its easy liquidity stance, using a calibrated mix of tools to stabilise financial conditions, it said. Liquidity has already eased meaningfully through 2025–26, and India Ratings does not see any immediate threat to the prevailing surplus. Although non-bank finance companies have increased short-term market borrowings, these remain within prudent limits and have not strained systemic liquidity, it said.

With policy rate cuts unlikely in the near term, open market operations are set to play a central role in liquidity management. India Ratings said the scale and timing of such operations will be influenced largely by foreign portfolio investment flows, which in turn depend on the evolving US–India tariff environment and the broader geopolitical risk trajectory. Any improvement on these fronts could further strengthen liquidity conditions.

Modest OMO may not be sufficient to materially lower funding costs, it said. To unclog the transmission channel and meaningfully compress yields, a sizeable and sustained programme of purchases will be required. Such operations would help ease the demand–supply imbalance in government securities and state development loan markets, while also giving banks greater room to gradually step up credit expansion, it said.

Banks’ appetite for statutory liquidity ratio securities has remained muted, adding to yield rigidity. Intensifying competition for deposits has reshaped balance sheet strategies, forcing banks to prioritise liability mobilisation at higher costs, it said. With households increasingly allocating savings to non-banking products, deposit accretion has lagged credit growth, constraining the transmission of policy easing. As a result, lending rates have declined more slowly than expected despite accommodative monetary conditions, it said.

Higher deposit costs and narrowing risk-adjusted spreads have also reduced banks’ preference for holding statutory liquidity ratio securities, it said. Banks have been selling such investments during market rallies, dampening demand for government bonds, particularly in the belly and long-end of the yield curve. This structural shift has reinforced downward rigidity in yields even as liquidity remains ample, it said.

The rating agency sees rising working capital requirements to lift demand for bank credit and commercial paper. 

India Ratings said non-banking finance companies to maintain elevated spreads in 2026–27, reflecting a more cautious growth approach amid emerging asset quality pressures, particularly in segments such as micro, small and medium enterprise financing, and NBFCs loan growth to moderate to about 15–16%.

India’s credit premia remain bifurcated as top-tier issuers continue to benefit from ample liquidity and competitive pricing, while lower-rated entities face wider spreads amid heightened risk aversion. Households’ rising indebtedness supports growth in parts of the financial system, but it also contributes to a mixed funding environment for weaker credits, the report said.

The rating agency expects short-term rates to stay firm, reflecting geopolitical uncertainty, rising working capital needs and tighter short-term liquidity. Banks are increasingly relying on certificates of deposit as a flexible liability management tool, and issuance is likely to remain strong. Alongside higher commercial paper borrowings, these dynamics point to an upward bias in short-tenor rates, even as headline inflation is expected to stay around or below 4%.