The Impact of the Recent Federal Reserve Rate Cut on Emerging Markets and India’s Financial Landscape
The recent decision by the United States Federal Reserve to cut interest rates by 50 basis points marks a significant turning point in global monetary policy. This move signals the end of a prolonged tightening cycle and is poised to lower borrowing costs worldwide, particularly benefiting emerging markets that rely on foreign debt. For countries like India, this shift presents a unique opportunity for non-banking financial companies (NBFCs) to diversify their funding sources and support the energy transition.
Global Implications of the Rate Cut
The Federal Reserve’s rate cut is expected to have far-reaching effects on global financial markets. Lower interest rates typically lead to reduced borrowing costs, which can stimulate investment and economic growth. Emerging markets, in particular, stand to gain as they often rely on foreign capital to finance their development projects. With the cost of borrowing decreasing, these nations can attract more foreign direct investment (FDI), which is crucial for their economic stability and growth.
In India, this environment creates a favorable backdrop for NBFCs, which have traditionally depended on bank borrowings. By tapping into global sustainable finance markets, these institutions can raise dollar-denominated capital to fund renewable energy projects, thus contributing to the country’s energy transition goals.
India’s Commitment to Green Lending
India’s financial sector is increasingly aligning itself with green lending initiatives. Banks and NBFCs have pledged a staggering ₹24.8 trillion (approximately US$296.65 billion) in loans to facilitate the shift to renewable energy by 2030. Key players like the Rural Electrification Corporation Limited (REC), Power Finance Corporation (PFC), and the Indian Renewable Energy Development Agency Limited (IREDA) are at the forefront, collectively committing ₹14 trillion (around US$167.47 billion) to this cause.
This commitment underscores the urgency of transitioning to sustainable energy sources, especially as India grapples with the dual challenges of energy demand and climate change. However, as lending to the power sector grows, concerns about concentration risk within banks have emerged.
Concentration Risk in the Financial Sector
The rapid expansion of NBFC lending to the power sector has raised alarms regarding concentration risk. Many NBFCs, particularly those focused on infrastructure and energy, are heavily reliant on bank borrowings. In FY2023, bank loans to NBFCs surged more than fourfold to ₹3.08 trillion (approximately US$36.84 billion). This dependency creates vulnerabilities; a downturn in the power sector or challenges faced by a few large NBFCs could have cascading effects throughout the financial system.
The Reserve Bank of India (RBI) has expressed concerns over the growing exposure of banks to NBFCs, particularly those linked to the power industry. In FY2023, the top 50 government-owned NBFCs accounted for 40% of the total corporate credit in the sector, amounting to ₹7.8 trillion (around US$93.3 billion). Such concentration introduces significant risks, prompting the RBI to tighten lending norms and increase risk weights for bank loans to NBFCs rated AAA to A.
Diversifying Funding Channels for NBFCs
In response to these challenges, many larger NBFCs are increasingly turning to the bond market for funding. Bonds offer long-term capital and reduce reliance on banks. In FY2025, NBFCs raised over 80% of the total bond market fundraising, although most issuances remain within the domestic market, where competition with banks and large corporates makes borrowing expensive.
Smaller NBFCs, however, face hurdles in accessing the bond market due to their higher risk profiles. To mitigate these challenges, many are adopting co-lending models, where banks handle underwriting while NBFCs source loans. This collaboration has resulted in co-lending assets under management approaching ₹1 trillion (approximately US$11.96 billion), reflecting a growing partnership between banks and NBFCs.
Additionally, a burgeoning private credit market is emerging through Alternative Investment Funds (AIFs), providing smaller NBFCs with another avenue for capital. AIFs have seen significant growth, with annual credit rising from ₹150 billion (around US$1.79 billion) in FY2019 to ₹666 billion (approximately US$7.97 billion) in FY2024.
Tapping into Offshore Markets for Sustainable Financing
Given the reduction in global interest rates, NBFCs should also consider tapping into offshore bond markets for cost-effective financing. The favorable environment created by the Federal Reserve’s rate cut allows power-focused NBFCs in India to access global sustainable finance markets and raise green debt. This influx of foreign capital can strengthen the Indian rupee and potentially lower domestic interest rates, further enhancing the financial landscape.
Moreover, larger banks should aim to access green financing lines through sustainable finance markets to co-lend with smaller NBFCs for clean energy projects. This collaboration not only diversifies lending into small, ticket-size clean energy assets but also helps mitigate concentration risk.
Conclusion: A Path Forward for India’s Energy Transition
As India embarks on its energy transition journey, the role of power-focused NBFCs becomes increasingly vital. By leveraging diverse funding sources and innovative financial models, these institutions can support the shift towards a more sustainable energy landscape. The recent rate cut by the US Federal Reserve presents a unique opportunity for India to enhance its green financing capabilities, ultimately contributing to a cleaner and more sustainable future.
This article was first published in The Hindu BusinessLine.