Indian loan growth to get lift as central bank cuts key rate again

Credit growth at Indian lenders should get a boost from the central bank's decision to cut its benchmark repo rate for the third straight time.

The Reserve Bank of India surprised markets June 6 by announcing a 50 basis-point reduction, following earlier cuts of 25 basis points each in February and April. The repo rate — the interest rate at which the Reserve Bank of India (RBI) lends to commercial banks — directly influences the rates banks charge their customers. A lower repo rate typically reduces lending costs, allowing banks to offer cheaper loans.

"This larger-than-anticipated rate cut is expected to reinvigorate credit momentum, particularly in the micro, small and medium enterprises and retail loan segments, which are highly sensitive to interest rate changes," said Rajan Pental, Executive Director at YES Bank.

Boosting credit demand

As of May 16, the loan books of India's scheduled commercial banks had notched growth of approximately 9.80% year over year. That marked a significant slowdown from the 19.53% growth in the same period last year, according to the RBI's fortnightly disclosures. The central bank had maintained elevated repo rates in recent years as part of a tight monetary policy stance to curb inflation, with the last rate cut prior to this year occurring in 2020.

Analysts project credit growth for major Indian banks to stabilize around 12% in the current fiscal year, citing headwinds from a slowing global economy and rising tariff tensions, according to S&P Global's Visible Alpha estimates. The RBI's latest rate reduction is expected to spur loan demand, particularly in rate-sensitive sectors such as real estate and automobiles, potentially improving banks' asset quality.

The repo rate cut may, however, compress banks' net interest margins in the short term, as lending rates are likely to decline faster than deposit rates. Banks may lower loan rates to remain competitive, while deposit rates typically adjust more slowly, squeezing profitability. This pressure is expected to be partially offset by the RBI's liquidity measures. Since January, the RBI has infused approximately 9.5 trillion rupees in durable liquidity into the banking system.

Starting in September, the central bank will also implement a 100-bps reduction in the cash reserve ratio, which is the total deposit share that a bank must keep as cash with the RBI, to ensure liquidity and control the money supply. That stands to further bring down the cost of funding for banks and release primary liquidity of about 2.5 trillion rupees by the end of the year.

The path ahead

The RBI's shift to a neutral policy stance from accommodative suggests that further rate cuts are unlikely in the near term.

"The central bank is likely to turn data dependent, and any further rate cut could come in only if growth surprises on the downside materially," said Sakshi Gupta, Principal Economist at HDFC Bank in a June 6 note. "It is likely that we will see no further rate cuts in the repo rate for 2025 now."

As of June 5, US$1 was equivalent to 85.82 Indian rupees.