(Illustration: Sudhir Shetty)
(Illustration: Sudhir Shetty)

RBI rate cut impact on your money

  • With repo-rate slashed to 6%, your home loan EMI is likely to reduce, but with a lag
  • If you are investing in debt funds stick to ultra-short term and short-term funds

Mumbai: Last week, when the Reserve Bank of India (RBI) cut repo rate — the rate at which the central bank lends to commercial banks – by 25 basis points (bps) to 6%, it sent out hope that your loans will get cheaper. One bps is one hundredth of a percentage point.

In fact, after the RBI reduced policy rates, finance minister Arun Jaitley told Hindustan Times that the government wants interest rate regime lowered to a level where paying equated monthly installments (EMIs) for home loans will be cheaper than paying rents. But can that become a reality? Besides your loans, here we tell you the impact of the rate cut on your other investment instruments as well.

Loans to get cheaper, but not immediately

Historically, whenever the central bank has cut rates, the monetary transmission has happened with a lag. Also the quantum of rate cuts is usually marginal. In fact, in the monetary policy report, the central bank points out that the one-year marginal cost of funds based lending rate (MCLR) declined by 5 bps during the easing phase, following the reduction in the policy rate by 25 bps in February.

Most banks link their loans to one year MCLR. “As long as deposits don’t grow, transmission of rate will be difficult. It will be difficult for the entire rate cut to get transmitted. They have cut repo-rate but the cost of fund is hardly going down," said Hatim Broachwala, analysts at IDBI Capital. Hence, you will see change in loan rates. However, the impact will be marginal and will come with a lag. It is advisable to opt for floating rate loans and avoid loans on fixed rates.

Deposits rates to remain unchanged for now

When key policy rates enter an easing phase, ideally your fixed deposit rates should also drop. However, considering high credit demand and lower deposit growth, banks would want to keep the depositors happy. Also, the higher rates at this point offered by small savings schemes and other fixed income instruments makes it difficult for banks to cut deposit rate.

Currently, small savings deposit offer around 8% returns, whereas bank deposits are in the 6.50% range. Considering that both fall in the same category, it puts pressure on banks to not ease rates. Hence, you will continue to see the current rates for some time. But eventually it should fall too. Most analysts expect deposit rates to revise after elections.

Ultra-short term, short term debt fund: no change

If you are planning to park your money in fixed income instruments such as debt funds, you would be better off looking at short-term and ultra-short term funds. In fact, the recent policy announcement has left the bond market unhappy.

“From a bond market point of view, there was a general expectation of something more — either a liquidity signal or stronger signal on growth and inflation. In absence of that and additional carve out from SLR, the demand of G-sec is expected to be reduced from the banking system. It will have an impact on the longer-end of the yield curve," said R Sivakumar, head-fixed income, Axis Mutual Fund. During the policy announcement, RBI allowed banks to reckon an additional 2% of G-sec within the mandatory SLR requirement. For investors, the advice is to stick to shorter-term bonds.

What should you do?

If you are a depositor, you may want to lock in at the current levels. If you are a new borrower, opt for floating rate loans. You can also negotiate with the bank on the charges and the spread over the interest rate. The concept of linking external benchmark to loan rate has now been postponed indefinitely. If you are investing in debt fund, you can continue looking at ultra-short term and short term funds.

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