The Reserve Bank of India‘s foreign-currency mobilisation has temporarily eased financial conditions and given the central bank more room to hold off on rate hikes, but the effect could prove short-lived as inflation, global interest rates and rupee weakness pose renewed risks, according to a research report by Systematix.
The domestic brokerage firm said FCNR(B) inflows have steepened the yield curve, pulling the five-year government bond yield down to around 6.47, while the 10-year yield has remained firmer at about 6.85 per cent. The easier financial conditions have reduced the immediate need for monetary tightening, although Systematix expects this calm to be fragile.
The report projects a potential 125-basis-point rate hike, taking the policy rate to 6.5 per cent, and sees a bear-flattening bias in the yield curve. It said inflation approaching 6 per cent in the second half of FY27, higher global rates and renewed rupee weakness could reverse the current easing in financial conditions.
The increase in liquidity has also translated into faster credit growth. Money supply growth has risen from around 10 per cent to 14 per cent, while industrial credit growth has surged to around 19-20 per cent. However, Systematix cautioned that the increase appears to be driven largely by companies meeting short-term working-capital requirements rather than a meaningful revival in private capital expenditure.
For banks, the benefits of additional liquidity may be limited. Despite the credit-deposit ratio climbing to around 82 per cent, net interest margins and returns on assets continue to moderate. Interest income is growing at only 6-8 per cent, compared with credit growth of around 18 per cent, indicating pressure on lending yields.
Systematix also flagged an asset-liability mismatch. FCNR(B) funds are largely raised for three to five years, while much of the lending they support is short-tenor. This creates a negative term spread, while the broader economic cost of the mobilisation is estimated at close to 8 per cent, after accounting for leverage, intermediation and the RBI’s carry.
Systematix expects the temporary liquidity boost to face pressure as inflation and global rates rise. The research house’s broader assessment is that the FCNR inflows can support financial stability in the near term, but they are unlikely to generate a sustained investment cycle unless private capex picks up.
