On Tuesday, during the annual policy review, the Reserve Bank of India (RBI) cut repo rate by 50 basis points. Is this outcome just important as economic news or does it have an impact on your finances and investments, too?
What is repo rate?
The repo rate, as it is famously known, or the repurchase rate is essentially the rate at which RBI lends money to commercial banks. This is the rate at which banks have access to funds or money; the lower the repo rate, the lower will be the rates that banks charge from customers and pay on deposits they take from customers.
RBI uses this rate to lend to banks so that they can meet their day-to-day requirements and this is lent against an approved list of dated government securities. These are then repurchased from the bank after a pre-fixed number of days as directed by RBI; hence the name of the charge is repurchase or repo rate.
Impact on your finances
A low repo rate signifies that banks are able to borrow funds cheap and subsequently, will lend to customers too at a relatively lower rate. For example, before Tuesday’s cut, the repo rate was 8.50% and current bank base rates are around 10-11%. However, go back a few years to 2004-end, the repo rate was 4.75% and banks were giving loans at roughly 7-8%. So, among other things, lower repo rates translate into lower bank base rates, which in turn mean low interest rates on your housing/personal/car loans or any other kind of loan you take from banks. It also means you are likely to earn less on your fixed deposits going forward.
Impact on your investments
The repo rate is also considered the benchmark rate for the economy. Typically, lower rates are seen as an aid to economic growth as finance is accessible at less cost and that helps people borrow money cheap to invest in ventures and to buy stuff. So, a cut in this rate is considered a signal to boost economic growth, which overall is a good move and gets reflected through positive reaction in equity markets. More specifically, stocks in sectors such as banking, automobiles and real estate, which are affected directly by rate reduction, tend to rally more. Thus, when repo rate cut is expected, other issues notwithstanding, equity markets in general go up and rate sensitive sectors, more specifically, rally. The reverse happens when repo rate is raised.
If you invest in bonds or bond funds, even there you are likely to benefit from repo rate cuts. Bond prices are inversely linked to interest rates. Prices go up when rates fall and vice-versa. Thus, in a scenario where rates are falling, bonds in the market with a long maturity like 5-10 years, offering high rates will look more attractive and result in a price rise. The change in price is more as the maturity for the bond increases.
Keep in mind though, in real terms, both equity and bond markets react to expected outcomes before the event actually happens.