Param Subramanian of Nomura added that, unlike previous rate-cutting cycles, banks now have a significant portion of their loan books tied to external benchmarks. This means a 50 bps cut by the RBI could negatively impact large private banks’ margins by 15-20 bps and their return on assets (RoA) by 7-10 bps.
Below is the verbatim transcript of the interview.
Q: The US Fed has cut. When do we start to see the cut here in India? In your experience, is this a big global easing cycle on the downside? How does it typically play out?
Mundra: If I look at it, the 50 bps cut has come as a bit of a surprise. But if we look at the US scenario, I think all forecasters were expecting a 25 bps cut, though the market was probably already building in a 50 bps cut. That was the scenario before the Fed meeting.
Now, with this 50 bps cut, what the Fed is likely signalling is that they are comfortable with the inflation trajectory. They are also factoring in that while inflation is at 2.5%, there will be a lagging impact, and it will be on course. They are probably focusing now on employment and growth. Interestingly, the forecast of a recession in the US has significantly increased in the last month, from almost 50% to 61%, and that’s the trigger.
However, there’s an interesting contrast between India and the US. In the US, consumer inflation is on a lower trajectory, but core inflation remains stubborn. In India, it’s the reverse: consumer inflation is stubborn, while core inflation, in parts, has even entered deflationary territory.
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I would say the expectation or desire is that the RBI will likely move with a 25 bps cut in its next policy announcement. There has already been significant divergence within the Monetary Policy Committee (MPC). Of course, we will have a new MPC and new members, but I expect a 25 bps cut. The RBI would also factor in some lagging impacts. If you look at the inflation reading in July and August, it’s already below 4%. The RBI will take a longer view and consider the trajectory over the next 6-12 months. But given the overall environment, the Fed’s actions, and emerging data, such as a slowdown in consumer-facing and investment-facing activities in India, a 25 bps cut seems likely.
Q: What is the impact on financials here in India? Could you break it down segment by segment? Are there any plays here from a stock perspective?
Subramanian: From a rate-cutting perspective, if you look at banks from a margin standpoint, this cycle differs from previous rate-cutting cycles. Banks now have a large portion of their loan books directly tied to external benchmarks. So when rate cuts occur, banks will face negative pressure on their margins and RoAs. Our rough estimate suggests that a 50 bps rate cut by the RBI would translate into a 15-20 bps negative impact on large private banks’ margins. At the RoA level, it could lower by around 7-10 bps.
Some smaller and mid-cap banks, which have higher fixed-rate exposures, may experience less negative impact on their margins and RoAs. However, these smaller banks often have exposure to riskier segments—microfinance, personal loans—which have been under scrutiny due to rising non-performing assets (NPAs). That’s the first-order impact.
From a second-order perspective, rate cuts generally lead to easier liquidity, a constraint for the sector as a whole. When liquidity improves, it benefits the banking sector’s growth. Historically, in two of the last three rate-cutting cycles, we have seen an improvement in current account/savings account (CASA) ratios across the sector.
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CASA profiles have sharply deteriorated over the last two years. However, in an accommodative phase, we would expect a less negative outlook on this front.
In terms of positioning, we are currently more inclined towards large private banks. Our preferred names are Kotak Mahindra Bank and ICICI Bank among the private players, and State Bank of India (SBI) among public sector banks. In the mid-cap space, we favour Federal Bank.
We don’t see a need to move down the risk curve. Although there is margin pressure, the sector as a whole is relatively cheap from a historical valuation standpoint.
Q: What about NBFCs? Many NBFCs have faced issues with the liability side, tight liquidity, and smaller players struggling to raise funds. From an investor’s perspective, do NBFCs, especially smaller ones, stand to benefit from rate cuts?
Subramanian: Yes, NBFCs are natural beneficiaries. We prefer NBFCs that don’t face significant credit cost or NPA pressures. We are more in favour of secured NBFCs, which will benefit from margin tailwinds as well as liquidity easing, without facing significant credit cost pressure. From this perspective, we like names such as Shriram Finance. Within the affordable housing space, Aadhar Housing Finance is a name our analyst favours. We also like Five Star, a small lender focused on SMEs. Secured NBFCs are the key beneficiaries.
Q: In all likelihood, we might see a 25 bps rate cut from the Reserve Bank of India. Let me ask a broader question: apart from the fact that one of the largest central banks is now in a rate-cutting cycle, does the RBI need to move on rates at all? Given that consumer inflation, as you pointed out, remains sticky, and the Governor has consistently stressed a vigilant stance on inflation, is there really a need to cut rates? Could liquidity measures, rather than rate cuts, be the solution?
Mundra: You are absolutely right, and that’s why I framed my earlier comment as a desire rather than an emphatic prediction of a rate cut.
In recent months, inflation has fallen below 4%, while growth remains strong. But if you look at the recent data on consumer-facing and investment-facing businesses, there has been a slowdown. Growth, while robust, is still below potential. That’s the tipping point. Given the US 50 bps cut and India staying put, the RBI faces another problem: capital inflows leading to rupee appreciation, which could hurt the export sector, already experiencing discomfort in recent months.
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So, it’s a balancing act. As I mentioned earlier, there’s been divergence within the MPC for quite some time, so perhaps the RBI may choose to signal a shift—either through a rate cut or liquidity measures. The Fed’s 50 bps cut cannot be ignored in the RBI’s policy announcement. That’s my point.