Short-term borrowing costs are likely to stay firm, while lower-rated non-banking financial companies (NBFCs) could face wider credit spreads as investors remain selective, according to India Ratings and Research (Ind-Ra). The rating agency said the interest-rate outlook was balanced, but risks were increasingly skewed upwards, citing resilient economic growth, strong credit demand, emerging inflationary pressures, geopolitical uncertainties and a firmer global rate environment. Any monetary policy tightening, stronger credit demand in the second half of FY27 and higher state development loan issuances could put further upward pressure on both short- and long-term interest rates. As per Ind-Ra, despite a year of low policy rate, market borrowing costs remain elevated, with both term and credit spreads widening recently, reinforcing a higher-for-longer rate environment.
Rising commodity prices and softer operating margins could increase corporate funding needs, driving greater use of bank credit lines and commercial paper. This is expected to keep both bank lending and money-market activity strong. According to Ind-Ra, rising working-capital requirements could support demand for short-term financing, with higher commodity prices and moderation in operating margins leading companies to draw more heavily on bank credit lines and rely more on commercial paper. The agency expects credit and term premia to remain elevated amid inflation risks, geopolitical uncertainty, external-sector concerns, healthy credit demand and continued pressure on banks' funding costs. Higher corporate bond and commercial paper yields are providing banks room to reprice loans and pass on higher funding costs, with this visible in the first quarter of FY27 when lending rates rose despite intense competition.
Ind-Ra has raised its FY27 banking system credit growth forecast to 15 per cent from 13 per cent earlier, above its 13.6 per cent deposit growth forecast. This would take the system loan-to-deposit ratio to 83.6 per cent. Strong credit growth, currency leakage, and balance-of-payments pressures have intensified the challenge of deposit mobilisation, prompting banks to rely more on certificates of deposit (CDs) and bond issuances and pushing up funding costs. While geopolitical tensions, inflation and weather-related disruptions pose downside risks, healthy credit demand and comfortable liquidity are expected to support steady CD issuance through FY27. Higher corporate bond and commercial paper yields are providing banks room to reprice loans and pass on higher funding costs, with this visible in the first quarter of FY27 when lending rates rose despite intense competition.
For NBFCs, the higher-rate environment is making risk capital more selective and expensive. Investors are favouring companies with strong liability franchises, resilient cash flows and disciplined balance sheets, while lower-rated and highly leveraged borrowers face higher funding costs, valuation pressure and longer fundraising cycles. According to Ind-Ra, spreads on AA− and above-rated issuers are expected to stabilise or rise moderately, reflecting higher supply and investors' preference for higher rates. Meanwhile, issuers rated below A could see further spread widening as investors remain selective. As per Ind-Ra, the real test for the credit market will be ensuring adequate access to growth capital for smaller businesses and financial institutions, with larger corporates having the balance sheet strength to navigate this environment.
System liquidity is expected to moderate from the third quarter of FY27, driven by festive-season currency leakage, a higher current account deficit, softer government spending and subdued capital inflows. While the immediate need for open market operation purchases has diminished, the possibility has not disappeared. External sector dynamics are likely to be a key determinant of liquidity conditions in the second half of FY27, with structural liquidity leakages and maturing foreign exchange forward positions potentially reducing surplus liquidity. Ind-Ra said these factors could limit any meaningful compression in risk premia. Structural liquidity leakages and maturing foreign exchange forward positions could gradually reduce surplus liquidity, potentially reopening the case for central bank bond purchases from Q4FY27 if capital inflows remain weak.
