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5 Impact of Recent RBI Repo Rate Hike on Financial Sector

Jun 27, 2018 | 2 years ago | Read Time: 3 minutes | By CA Sandeep Vinod Kanoi

The Reserve Bank of India has increased the repo or repurchase rate to 6.25 percent by 25 basis points after a layover of four years. The apex bank raised the repo rate last in the year 2014 when it went from 7.75 percent to 8 percent. With this hike, RBI has reversed its rate cutting cycle which it had engaged since 15th January 2015.

Repo or repurchase rate refers to the rate at which the Reserve Bank of India lends funds to all commercial banks in the country. So, when RBI hikes the repo rate, it makes borrowing costly for the banks so the banks consecutively hike the lending rates for their customers and pass this burden to the end customers.

Effects on Inflation

With this increase in the repo rate, banks would be compelled to pay more interest to the Reserve Bank of India which prompts them to hike the lending rates for their customers. The borrowers then are deterred from taking credit from the banks which leads to a shortage of funds and liquidity issues in the economy. So, on one hand, inflation is checked as there’s less money in the hands of the public to spend, on the other hand, growth suffers as corporates avoid going for loans at high interest rates which leads to a shortfall in expansion and production.

Effects on fixed deposits

With the increase in repo rate, the availability of funds for the commercial banks is scarce as the banks won’t be willing to borrow at the repo rate. In turn, they might have to hike the interest rates on deposits for attracting depositors. Hence, with a hike in the repo rate, there’s a probability of high-interest rates on fixed deposits.

The short-term impact of this hike doesn’t foretell well for the investors investing their money in FDs. RBI’s long term policy is now aimed to fight retail inflation. Once inflation rates are lowered substantially, the prospect of parking funds in FDs over long-term would offer lucrative benefits. The immediate effect on FDs might be a damper; however, banks are unlikely to reduce the interest rates on deposits as of now.

Effects on borrowing

Most of the financial experts are of the view that the impact of hike in the repo rates might not necessarily get translated immediately into higher rates on deposits. However, as this move was expected by the lenders, the interest rates on loans have gone up already. It would mean higher EMIs on Car Loans, Personal Loans as well as Home Loans.

Effects on home loan

For the existing borrowers, the burden of EMI would only increase as the banks have started hiking the interest rates. However, such increase in EMI would be felt by the borrowers only when reset date of their home loan arrives. On such date, the future EMIs would be calculated as per the MCLR effective on such date.

In case the interest rates on home loan increases after such reset dates then an existing home loan borrower could compare home loan interest rates offered by other banks and calculate their potential savings. In case the savings are considerable, the borrower should first try negotiating with the existing lender for reducing the rate. If that doesn’t work out, then the borrower could look to for transferring his home loan to another lender.

Effects on economy

According to the experts, increasing the repo rates was a right move by the RBI with the global backdrop of Fed’s rate policy, rising oil prices and fact that many emerging economies have already hiked their rates. Emerging markets are opting for rate hikes for defending their currencies. However, some of the experts are also worried that this increase in repo rate might put a dent in the growth rate, which was recovering after blows from demonetization and the launch of GST (Goods and Services Tax).

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