Short-term rates to stay firm as credit demand, funding needs rise: Ind-Ra

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, India Ratings and Research (Ind-Ra) said.

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. Spreads for higher-rated NBFCs may remain stable or rise moderately amid higher supply.

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 the financial year 2027 (H2FY27) and higher state development loan issuances could put further upward pressure on both short- and long-term interest rates, it said.

“Despite a year of low policy rate, market borrowing costs remain elevated, with both term and credit spreads widening recently. Interest rate drivers have broadened from external pressures to include strong domestic growth and inflation, reinforcing a higher-for-longer rate environment. While larger corporates have the balance sheet strength to navigate this environment, the real test for the credit market will be ensuring adequate access to growth capital for smaller businesses and financial institutions,” said Soumyajit Niyogi, director, Core Analytical Group, Ind-Ra.

Ind-Ra expects system liquidity to moderate from Q3FY27, driven by festival-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 agency said the possibility had not disappeared.

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. External sector dynamics are therefore likely to be a key determinant of liquidity conditions in H2FY27.

The agency said corporate India had remained resilient through successive economic and geopolitical shocks, with larger and diversified companies benefiting from stronger balance sheets, operating leverage and pricing power. Most shocks have been absorbed through earnings rather than weakening balance sheets, allowing large corporates to maintain relatively strong credit profiles.

However, 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.

Ind-Ra 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. The agency said these factors could limit any meaningful compression in risk premia.

Higher rates could nevertheless support banks’ profitability through repricing. 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.

At the same time, higher corporate bond and commercial paper yields are providing banks room to reprice loans and pass on higher funding costs. Ind-Ra said this was visible in Q1FY27, when lending rates rose despite intense competition, and expects the upward bias in lending rates to continue.

The agency 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. 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.

Ind-Ra also expects rising working-capital requirements to support demand for short-term financing. Higher commodity prices and moderation in operating margins could lead companies to draw more heavily on bank credit lines and rely more on commercial paper, sustaining activity across both bank lending and money markets.

For NBFCs, the agency expects spreads on AA- and above-rated issuers 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.