Global central banks have responded to the intensifying war in West Asia, inflationary risks, rising bond yields and ongoing trade uncertainty by raising interest rates in their home economies. A rate hike appears imminent in India too: nine out of 10 economists in a Mint poll expected a 25 basis point increase in the policy repo rate later this week. The pressure to tighten monetary policy comes at a time when bank lending is strong, with non-food bank credit growing at 14% or more year-on-year since December 2025. The deployment has been broad-based across sectors.
This begs the question: Will a rate hike, or even a change in monetary stance from neutral to tightening, suppress this credit upcycle? In theory, it should, because higher rates are expected to dampen credit demand. However, in practice, the connection between the two is neither automatic nor straightforward.
How credit responds is a function of the length and intensity of monetary tightening, as well as the strength of factors driving credit uptake. Under current conditions, three supportive factors are visible: controlled inflation, strong growth and a lack of financial deepening.
Three-factor push
First, initial conditions are favourable for credit growth. Headline is within the 2-6% tolerance band despite rising oil prices and a weaker exchange rate. The economy is forecast to grow by 7% in the current financial year. In addition, systemic liquidity has been boosted by the from special foreign currency non-resident bank (FCNR-B) deposits, which have since been swapped into rupees. These inflows have pushed down short-term rates significantly.
For banks, ample liquidity has two immediate consequences: availability of cheap funds for lending and reduced reliance on high-cost certificates of deposit (CDs). The former adds to revenue, while the latter lowers the cost of funds. The overall impact has been positive for margins. Indeed, issuances of CDs fell from ₹1 trillion in the fortnight ended 15 June to ₹195 billion in the fortnight ended 31 August. Though CD issuances have risen in the latter half of September, the earlier gains could still materialize.
According to SBI research, assuming a conservative credit multiplier of 2.5, FCNR inflows of $127 billion (or roughly 12 trillion) could result in additional credit of over ₹25 trillion. At a yield of 7.5%, this translates to an additional ₹1.8 trillion in gross revenue.
Second, demand for bank credit does not depend on interest rates only. In the past, strong economic growth has generated enough credit demand to overrule the impact of high interest rates. For instance, the massive credit boom of 2004-07 unfolded when lending rates were around 12-13%, but real growth was also strong at about 8%.
An RBI research suggests a bi-directional relationship between credit and economic growth, as well as credit and investment growth. In other words, credit flows support growth in investment and GDP, and a growing economy increases demand for bank credit. If the economy grows strongly, credit growth is likely to be strong too. After all, banks are the primary source of funding for most corporations. In 2025-26, non-food credit accounted for 62% of the total flow of resources to the commercial sector. Bank financing is critical in India because the corporate bond market is underdeveloped and bond issuances are limited to the highest-rated companies.
Third, India’s financial deepening is a work in progress, especially in terms of access to finance by companies. The World Bank’s Enterprise Survey 2025 shows that 97.6% of Indian firms had a bank account, but only 21% had a bank loan or line of credit.
One reason is the credit constraints faced by (MSMEs). A 2025 Small Industries Development Bank of India (Sidbi) survey also revealed a credit gap of ₹30 trillion for the MSME sector. While the government has taken several measures to improve the flow of credit, such as credit guarantee schemes, India has a long way to go before it achieves the credit access levels of emerging market peers such as Vietnam or China.
The good news is that India’s bank credit has grown rapidly over the past year, reaching 61.6% of GDP in 2025-26, after stagnating around 50% for nearly two decades. If this sustains, it could prove to be a pivotal point in the structural shift to a higher level of credit. This will, in turn, support growth and credit access.
Window of opportunity
An often overlooked, but important factor, is that rate hikes are positive for bank net interest margins (NIMs). Most bank loans to corporates are floating rate loans linked to an external benchmark, which get automatically repriced when interest rates go up.
However, deposit costs increase with a lag, because it takes time for existing deposits to mature and be repriced at higher rates. This results in a reasonable window of time in which bank NIMs widen—a circumstance that makes banks willing to lend. At the same time, the present low level of non-performing assets allows banks to lend without undue risk aversion.
Taken together, these factors suggest that robust economic growth, healthy bank balance sheets, and policies to improve credit availability could reduce credit sensitivity to monetary tightening. However, no credit cycle can withstand prolonged rate hikes.
If oil prices remain higher for longer and interest rates are increased sharply, may take a hit, indirectly impacting credit growth. A shallow rate cycle may not be a threat, but a steep one still has the potential to damage credit growth.
The author is an independent writer in economics and finance.