Once again, the RBI has hiked the repo rate. This will have an impact on borrowers as well as depositors.
For the first time in 5 years, the Reserve Bank of India (RBI) has gone for a back-to-back hike in the repo rate, increasing it by 25 bps. Releasing its bimonthly monetary policy, RBI increased the short-term lending rate or repo rate to 6.50% from the existing 6.25%. The main reasons behind the rate hike are rising oil prices and a rise in inflation.
What is RBI’s logic?
“Retail inflation, measured by the year-on-year change in the CPI, rose from 4.9 percent in May to 5 per cent in June, driven by an uptick in inflation in fuel and in items other than food and fuel, even as food inflation remained muted due to lower than usual seasonal uptick in the prices of fruits and vegetables in the summer months. Adjusting for the estimated impact of the 7th central pay commission’s house rent allowances (HRA), headline inflation increased from 4.5 percent in May to 4.6 percent in June.”
Now, the question is, will this impact you as a borrower and depositor? The answer is, yes! Let us take a look at how RBI’s repo-rate policy impacts Loans and Fixed Deposits.
Understanding the Repo Rate
Before getting into the reasons why the increase in repo rates may be bad news for borrowers because of increased loan EMIs, it is essential to understand what the repo rate is and how it will impact the banking system.
In simple terms, the repo rate is the rate at which the RBI lends money to commercial banks. The increase in the repo rate would mean that the RBI will charge a higher rate of interest for all the money that it lends to various commercial banks. The bank, in turn, will be forced to charge its borrowers more.
Additional Reading: What Exactly Does The RBI Do?
Impact on Deposit and Lending Rates
Higher repo rates have already translated into higher deposit rates. Many banks, such as State Bank of India and Axis Bank, have hiked deposit rates. However, since this move was anticipated by lenders long ago, the lending rates have already gone up manyfold. This would effectively mean higher EMIs on Home Loans, Car Loans as well as Personal Loans.
The Home Loan segment is likely to face the brunt of this increase in repo rate. This is because Home Loan rates are usually floating-rate loans that change along with the interest rates in the country. Also, the amount of loan taken by a borrower is usually much higher than that of a Car Loan or Personal Loan. So, any increase in Home Loan interest rates will mean a higher interest payout for the Home Loan borrower.
Consider this: Suppose you have taken a Home Loan of Rs. 60 lakhs for 20 years at 8.25%. You will be paying an EMI of Rs. 51,124. Your total interest outgo will be Rs. 62.69 lakhs. With an increase of 0.25% in your Home Loan rate, your EMI will work out to Rs. 52,069 and the total interest will be Rs. 64.96 lakhs. You will be paying Rs. 2.27 lakhs more. What if interest rates go up by 0.5%? Then, you will be paying a total interest of Rs. 67.25 lakhs. This means an additional payment of Rs. 4.66 lakhs! The below table will help you understand the impact of the interest rate hike.
|Interest rate hike||Home Loan rate||EMI (Rs.)||Additional EMI (Rs.)||Total Interest Payment (Rs.)||Additional Interest Paid Due To Rate Hike (Rs.)|
*Calculations are for a Home Loan of Rs. 60 lakhs for 20 years.
Want to calculate it for your Home Loan? Try BankBazaar’s Home Loan EMI calculator.
Want to know the views of industry experts? Here they are!
Adhil Shetty, CEO, BankBazaar.com
“The repo rate hike was somewhat expected. The RBI had been mandated to keep the inflation rate at 4%. Today, we have a situation where the 4% mark has been exceeded for eight straight months. In June, inflation was at 5%. Along with this, the rupee has weakened, crude prices remain volatile, and government expenditure is expected to rise with the upcoming Lok Sabha elections. The RBI continues to maintain a neutral stance on policy rates.
Impact on FDs
With an increase in policy rates, bank deposit rates are expected to rise as well. Just one day back, the SBI hiked its deposit rates by 5 to 10 BPS. This means marginally higher interest earnings for customers opening Fixed Deposits with banks.
Impact on Loans
Loans will get marginally costlier. In June, several leading banks, including SBI, had increased their MCLR. With the rate hike today, we’ll see loans get costlier. On a loan of Rs. 1 lakh for 20 years at an interest rate of 8.5%, the EMI is Rs. 868. If the rate rises to 8.75%, the EMI increases to 884. If the interest rate reaches 9%, the EMI becomes Rs. 900. In a rising rate scenario, it makes immense sense for customers repaying loans to make periodic principal pre-payments. This is especially helpful while you’re in the first half of your loan tenure. Pre-payments made in the first half have an immense impact in reducing your long-term interest outgo and thus ensuring savings.
Impact on Equity and Equity Mutual Funds
In recent years, we had seen heavy inflows into the equity markets corresponding with a steady drop in interest rates. The intrepid investor seeking higher returns chose equity in this period. As a result, Mutual Fund AUMs grew at a tremendous pace. The investor with a risk appetite can continue to invest in equity with the expectation of above-average returns in the long-term.
Impact on Debt Funds
Rising rates are bad news for Debt Mutual Funds investors. This is because the prices of bonds fall, and bring down the NAV of debt funds. It would be advisable for investors to steer clear of long-term debt funds and go for funds with shorter maturity periods. Short-term debt funds are expected to deliver lower volatility and low risk in this scenario.
Impact on Small Savings Scheme
With two consecutive hikes in the repo rate, taking it to 6.50%, there is now heavy expectation of increase in small savings returns. For the April to June quarter, the rates remained unchanged. Investors looking for risk-free, guaranteed returns may continue to invest in PPF, NSC, Sukanya Samriddhi, Post Office Savings etc.”
Additional Reading: The New RBI Governor: Urjit Patel
Naresh Takkar, MD & Group CEO, ICRA
“Given the persistence of various inflationary risks amid a near closing of the output gap, the Monetary Policy Committee (MPC) members chose 5:1 to raise the repo rate by 25 bps to 6.5% in the August 2018 policy, in line with our expectations.
Their anticipated decision to retain the stance of monetary policy at neutral instead of modifying it to withdrawal of accommodation, suggests that the future rate action would remain data dependent. Depending on the impact of various risks on the evolving inflation outlook, a final rate hike of 25 bps may emerge towards the end of FY2019.
The maintenance of the neutral stance cooled bond yields after the policy announcement, as the rate hike itself was already priced in. Looking ahead, we expect the 10-year G-sec yield to trade in a range of 7.65%-8.0% in the remainder of this quarter. Greater clarity on MSPs, crude oil prices and other inflationary trends, fiscal risks and the Central and State Government borrowing programme for H2 FY2019, may emerge as triggers for a rise in bond yields. On the other hand, the announcements of additional open market operations by the RBI could help cap the G-sec yields.”
Pankaj Pathak, Fixed Income Fund Manager, Quantum AMC
“With two back-to-back rate hikes, the RBI has reaffirmed itself as a proactive inflation targeting central bank. The 25 bps hike is broadly in line with the market expectations and is unlikely to move bond yields substantially in any direction.
The “neutral” policy stance indicates that this tightening cycle will not be very extensive. However, the RBI may remain vigilant over upside risks to inflation emanating from MSP hikes, higher government spending and improving rural demand.
If the CPI inflation expectations exceed the 5% April-June 2020 forecast of the RBI, we should expect the repo rate to then move towards the 7% mark. But for now, we expect them to remain on hold for the rest of 2018.
Bond markets may find support from increased OMOs by the RBI in the second half of FY 19. Bond yields for short maturity papers between 1-5 years continue to remain attractive.
We expect deposit and lending rates to increase in the coming months.”
Jayant Manglik, President, Religare Broking
“The RBI hiked interest rates by 25bps along expected lines citing various risks to the inflation outlook, as it maintained the monetary policy stance at neutral. While acknowledging the recent cool-off in crude oil prices and the reduction in GST rates, which may have a disinflationary impact on inflation, the policy repo rate has been hiked in the backdrop of the uncertainty and volatility surrounding various inflation-impacting factors. These include global crude oil prices, global financial market volatility, input cost inflation, progress and distribution of monsoon, economy’s fiscal condition, the recently announced MSP hike and global trade protectionism, among others. However, by maintaining the monetary policy stance at neutral, we believe the RBI has retained some amount of flexibility as far as the rate decisions in the foreseeable future are concerned, which could be highly data dependent.”
Additional Reading: RBI’s New Relaxed Rules For Opening Bank Accounts!
What Should You Do?
Ideally, you should wait to see if your lender hikes interest rates. If your interest rates are hiked substantially, then you can consider a balance transfer to another lender. Says Adhil Shetty, “an existing borrower may not immediately witness any change in their EMI amount, but a higher interest rate would eventually increase the long-term interest out-go. One of the ways to protect yourself is by making a pre-payment that would lower your overall interest outgo. This would be particularly a good move for those at the beginning of their loan tenure.
But if you are nearing the end of your loan, it is wise not to take any steps and simply maintain the loan till the end of its tenure to collect any useful tax deductions. You can also adopt a wait and watch policy for a quarter and take time to understand the impact of the rate hike on your loan. If there is a significant impact, you can explore transferring the Home Loan to other banks after a comparison of the rates offered to grab the best deal.”
Additional Reading: Interest rates to be linked to external benchmarks from April 1
However, you will need to compare across lenders and check for the best rates. Don’t forget to look for lower processing fees and discounts for women borrowers. You can do that right now. The best offers are waiting for you!