Clipped from: https://www.thehindubusinessline.com/opinion/expect-an-extended-pause-in-rates/article69906884.ece
With inflation expected to remain elevated in FY27, there’s little headroom for further rate cuts
Interest rate transmission is yet to fully play out on bank deposit and lending rates | Photo Credit: sommart
The Monetary Policy Committee (MPC) of Reserve Bank of India (RBI) unanimously decided to keep the benchmark rates unchanged following the higher-than-expected cut in the previous policy action. The MPC also simultaneously decided to keep the policy stance “neutral”. The decision to hold the rates seem driven more by the RBI retaining its GDP growth forecast of 6.5 per cent for FY26 and 6.6 per cent for Q1FY27, and the likely increase in core inflation indicators by the end of the fiscal despite the recent softening of the headline inflation.
Despite the moderation in industrial growth and uncertainty related to the external sector, the MPC highlighted resilience in the services sector and consumer demand in the rural segment, with expectations of revival in urban consumer demand driven by the impact of past measures.
Even as core inflation remains steady at 4.1-4.2 per cent, the MPC has revised its inflation estimates for FY26 to 3.1 per cent from its earlier forecast of 3.7 per cent due to negative food inflation. The forecast for Q1FY27 is however as high as 4.9 per cent, given the adverse base effect. With repo rate at 5.5 per cent, the projected inflation rate for Q1 FY27 leaves a little headroom for further rate cuts, unless the growth materially slows down from the current estimate.
With inflation for the subsequent quarters of FY27 expected to remain elevated, an extended pause is likely going forward. The neutral policy stance will provide flexibility to the MPC to take data dependent rate actions on either side depending on domestic or external developments.
Transmission of rate cut
On the back of various liquidity infusion measures since February 2025 and slower bank credit growth, the daily average surplus liquidity doubled to ₹3.1 lakh crore in July 2025 from ₹1.5 lakh crore in April 2025. However, the transmission is yet to fully play out on bank deposit and lending rates as the drop is significantly lower than the decline witnessed in market instruments.
With the commencement of a 100-basis point cut in cash reserve ratio (CRR) from September 2025 onwards and fully implemented by end-November, the liquidity position shall remain in surplus and improve transmission in banks’ lending and deposit rates. The deposit base of banks is likely to reprice downwards in H2FY26 and continue in FY27. This shall support continued transmission in lending rate of banks on fresh as well as earlier loans.
While the transmission of rate cuts has been swift in the money market and short-term debt instruments amid surplus liquidity conditions, the transmission has been limited in the medium- or longer-term bond yields. The 5-year and 10-year G-sec yield declined by 63 bps and 28 bps, respectively, since February 2025. Over the same period, 5-year AAA corporate bond yields declined by just 56 bps.
Despite the 50-bps cut in repo rate in June 2025, the yield on 10-year G-Sec is higher at 6.39 per cent compared to 6.18 per cent prior to the policy announcement. Further, the bond yields have risen as the expectations of any rate cuts in the upcoming MPC meetings appear to be low, given the outlook on inflation for Q1FY27.
Nonetheless, the yields on highly rated corporate bonds remain lower than the lending rates of the banks, which shall continue to drive corporate bond issuances in the near-term. Notably, the corporate bond issuances had touched an all-time high for any quarter during Q1FY26 and stood at ₹3.5 lakh crore.
With credit growth slowing to 10 per cent YoY as on July 11, 2025, as compared to 13.9 per cent as on July 12, 2024, the status quo on rates would be a breather for banks as it saves them from another downward pricing of their loan books linked to external benchmarks. The faster transmission of rates in the capital markets meant that the competition posed by corporate bonds and money markets instruments like CP continue to weigh on the credit growth of banks. The credit growth should start improving in H2FY26 and grow at 10.4-11.2 per cent for FY26, similar to that in FY2025.
However, global developments amidst the tariff-related uncertainties may prevent a sharper acceleration in credit growth despite the RBI’s steps to revive growth.
The writer is Senior Vice President, Group Head – Financial Sector Ratings, ICRA
Published on August 8, 2025
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