How Does the RBI's Repo Rate Affect You?

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Equirus Wealth

05 Dec 2022 5 min read

Compliance#Loans#Mutual Funds#Savings#Investment

The current repo rate in 2022 was 5.90%, according to the 30th September 2022 update, when the was raised by 50 basis points by The Reserve Bank of India (RBI).

What is the RBI repo rate & Reverse Repo Rate?

The Repo Rate is the rate at which a nation's central bank (in India, the Reserve Bank of India) sanctions loans to commercial banks in the event of a funding shortage. The repo rate is used by monetary authorities to control inflation. The reverse repo rate is the interest rate at which a nation's central bank borrows money from domestic and commercial banks.

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What happens when the Repo Rate increases?

The hike will directly impact the banks' lending rates in the repo rate. To compensate for the increased repo rate, the banks will undoubtedly increase the interest rate they charge borrowers. The cost of home loans, personal loans, and other credit options will rise. If you have customers who have house loans with fluctuating interest rates, this move in the repo rate will affect you the most.

What happens when the Repo Rate decreases?

As other lendings and interest rates are correlated with the repo rate, a decline in the repo rate will likely result in a reduction in the interest you pay on your mortgage, car loan, or savings and investment products. This repo rate change implies that your debt payback obligations will become smaller each month.

Why does the RBI increase the Repo Rate?

The RBI can reduce the surplus liquidity in the economy and keep inflation under control by raising the repo rate.

What is the Impact of Repo Rate Change?

Economic Growth

Despite being necessary to combat inflation, successive rate increases over a brief period are predicted to impact economic growth negatively. As price increases, the underprivileged segments of society will no longer be able to afford goods and services. The RBI has decided to raise the repo rate to focus on managing inflation, even at the expense of economic growth.

Effect on Loans and Other Credit Instruments

The increase in the repo rate will immediately impact the banks' lending rates. The banks would probably raise the interest rate they charge borrowers to compensate for the increased repo rate. Home loans, personal loans, and other credit facilities will become more expensive. This repo rate change will most impact you if you have home loan customers with floating interest rates.

Inflation

The RBI announced that it would continue to remove its accommodative posture while promoting growth, raising the repo rate by 190 basis points this fiscal year. "The move to increase the rates was in accordance with the global cues and done to manage the headline inflation in the nation," RBI Governor Shaktikanta Das said in his speech.

It is predicted that these price hikes will cause inflation to decrease, allowing the RBI to take a breather. Regarding policy rates, it is also believed that the economy is close to reaching its top and that further RBI repo rate increases are unlikely.

Fixed Deposit Rates

Every time the repo rate increases, there will be a hike in bank deposit interest rates. According to financial experts, customers with short- and medium-term assets, such as fixed deposits and savings, may profit from higher rates as they will get higher returns from their investments based on how banking institutions react to the most recent interest rate hike.

Debt Mutual Funds

Bond prices decline when yield increases, which lowers the return on debt investments. Due to this, you are compelled to withdraw your funds from the market to wait for the bond price to increase and increase your profits. Debt funds can experience short- to medium-term volatility. Longer-duration funds will be more affected by yield movements because they are more sensitive.

Increased Borrowing Cost

The cost of borrowing rises when repo rates rise. The increase in interest rates by the RBI will also affect home sales growth. In response to the continual rise in the price of raw materials, builders across the nation will increase real estate prices.

Consumer Spending

When borrowing prices increase, people are deterred from making significant purchases, which lowers the demand for products and services. Also, if inflation starts to slow down in the medium term, the average person will profit from higher spending levels.

Stagflation

An increase in the repo rate produces ripple effects. When obtaining loans becomes expensive, companies cut or stop employees, which results in unemployment.

Savings

Higher rates are beneficial for those with savings and fixed deposits.

EMIs for Loans

The optimism of new homebuyers will be undermined if banks boost interest rates and current borrowers' EMIs become even higher.

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Final Thoughts

RBI continually adjusts the repo rate and the reverse repo rate in response to shifting macroeconomic circumstances. Though differently, all economic sectors are impacted each time the RBI modifies interest rates. Some market segments profit from the rate increase while others suffer.

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