Investors in private credit will have to reset their risk-return expectations as they navigate the lower interest rate regime
In 2025, the RBI cut the repo rates by 100 bps (1 per cent). In the last rate cut, the quantum of cut, i.e. 50 bps and the accompanying CRR rate cut of 100 bps was the surprise element. While these actions have ensured liquidity and availability of funds at lower cost, it has also opened up avenues for corporates to refinance their high-cost loans.
The last few years have seen the government doing the heavy lifting in terms of capital expenditure to support economic growth. Corporations, recovering from the shocks of the COVID pandemic, were focused on survival rather than growth. According to CMIE data, the number of projects involving capex investments declined from 4,711 in 2022 to 2,731 — a drop of nearly 50%, thereby painting a bleak picture across industries.
Corporates focused on deleveraging their balance sheets, as evident from the CMIE data, which shows net-debt-to-equity for listed companies collapsing from 1.55x in FY20 to just 0.50x in FY24. Bumper cash flows and a post-COVID obsession with discipline have led to robust corporate deleveraging, though investment boards remain cautious, spooked by pandemics, supply chain chaos, and geopolitics. Lack of demand from the corporate sector led the banks to turn aggressively towards retail loans.
As per a CRISIL market intelligence report, NBFCs now have nearly 48.1% of their lending book in retail, rising steadily from 42.8% in FY20, 44.9% in FY22, and 47.9% in FY24. This upward trend reflects a clear structural shift towards retail, gradually crowding out corporate and wholesale lending.
Banks were also wary of taking credit risk on corporates who were seeking loans during the upward trajectory of the rate cycle (From a 4% repo rate in April 2022 to a 6.5% in December 2024). Thus, corporates who were seeking loans turned towards private credit funds — AIFs, distressed funds, or special-purpose vehicles that operate outside of the traditional banking system. These funds deploy debt capital to entities that may not have access to capital via plain vanilla bank loans. However, these loans are available at higher rates than the typical bank loan. This capital, however, also differs from traditional loans in that it is often structured, tranched, and layered with features such as contingent exits or equity conversion. Thus, private credit fuels economic growth by accelerating capital into areas of distress, growth opportunity, and young MSMEs.
India is emerging as one of the largest players in APAC — a market that was previously focused on collateral-based lending. The Indian market has seen more than 10x growth in the private credit space. Calendar Year 2024 has seen total private credit investments of USD 9.2 billion across 163 transactions.
While private credit funds filled a critical credit gap, many borrowers viewed private credit as a temporary bridge until conditions improved for them to return to mainstream banking channels. Now, with the RBI signalling a lower interest rate scenario and credit re-rating happening for the corporate sector on the back of lower overall debt, the banking sector should see green shoots for improved credit flow.
The immediate opportunity is for loan refinancing, where corporates would look to refinance their high-cost debt. Borrowers paying 16–18% to structured funds will now seek to swap into 12–14% bank loans. High-yield lenders, in turn, would take their exits from these portfolios. This trend is already visible in select sectors, including real estate, infrastructure services, and industrials, particularly where operational risk has reduced and bank appetite has returned.
For instance, as per EY’s Private Credit H2 2024 report, Edelweiss Alternates’ ₹7.4 bn investment into Adarsh Developers clocked 20–25% IRRs — a good template. The exit for the private credit funds could also accelerate as firms will eye the public market for funds, driven by improvement in credit metrics and credit upgrades. Every rupee repaid to the fund goes hunting for the next dislocation: mid-market machinery upgrades, supply-chain logistics, renewables, real estate, and more, albeit at a higher level of credit risk.
The moot question is whether private credit funds would go that way in pursuit of a higher spread, given that the market rates have eased? Alternatively, the investors in private credit funds will have to brace themselves for lower yields, in the face of competition from the banks and lower market rates.
The RBI rate cut matters more in the shadows — letting private-credit investors exit with high IRRs, reload their guns, and underwrite India’s next capex. The banks will restart their lending to larger corporates, leaving the smaller and riskier firms to the private credit funds. However, instead of moving on the higher risk scale, the prudent way forward for private credit would be to wait out for the rate cycle reversal.
Should credit funds choose to move to higher risk loans, they would find it difficult to exit those positions profitability, given the higher risk involved. If the rate cycle moves higher, the situation could turn worse for credit funds. One potential avenue for higher yields in private credit funds would be to focus on niche situations, such as structured debt or financing special situations that traditional banks tend to avoid. Otherwise private funds would be better off by maintaining the dry powder. For the next phase won’t reward the fastest deployers, it will reward the most disciplined underwriters.
No VCCircle journalist was involved in the creation/production of this content.
