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Business News/ Money / Personal Finance/  How RBI repo rate hike can impact the loan and fixed deposit rates?

How RBI repo rate hike can impact the loan and fixed deposit rates?

To reduce continuing inflation challenges, the Reserve Bank of India (RBI) lifted its key repo rate, or the key lending rate, by 35 basis points on Wednesday, to 6.25% from 5.90%.

The RBI has raised the key lending rate five times in a row. Since May, the board has now increased the key rate by 225 bps in FY23.Premium
The RBI has raised the key lending rate five times in a row. Since May, the board has now increased the key rate by 225 bps in FY23.

To reduce continuing inflation challenges, the Reserve Bank of India (RBI) lifted its key repo rate, or the key lending rate, by 35 basis points on Wednesday, to 6.25% from 5.90%. The RBI has raised the key lending rate five times in a row. Since May, the board has now increased the key rate by 225 bps in FY23. Retail price inflation in India reduced to 6.77 percent YoY in October 2022 from a five-month high of 7.41 percent in September. However, the fact that it continued to be above the central bank's acceptable limit of 2 to 6 percent for a tenth consecutive period prompted RBI to raise the repo rate for the fifth time. The banks would probably raise the interest rate they offer borrowers to make up for the elevated repo rate. Home loans, personal loans, and other sources of credit could therefore become more expensive.

Mr Ankit Mehra, CEO and Co-founder of GyanDhan said “RBI raised the repo rate by 35 basis points to 6.25% for the fifth consecutive time this year. It was expected as inflation has remained above the tolerance band for the 10th month in a row. It has a direct impact on education loan borrowers. Preeminently, loans given are with a floating rate of interest. Interest rates are bound to increase, resulting in a higher EMI. Since most students apply for a loan with a parent as a co-borrower, this gradual increase in the rates is a sign of worry. As for the deposit rates, the decision to increase rates lies with the individual lender and bank. While the RBI Governor clearly stated that inflation seems to be easing out, the economy cannot slide into complacency and “have to be watchful nimble in our actions". With this statement, we can expect further hikes, albeit of a smaller rate increase."

Dr. Suresh Surana, Founder, RSM India said “Repo rate is the interest rate levied when commercial banks borrow funds from RBI and any shift in the repo rate determines the relative shift in rates for the loans and deposits. When the repo rate increases, the borrowing cost for the commercial banks rises which is passed on to the retail investors and vice versa. Thus, the repo rate is intrinsically linked to the loan and deposit rates offered by the commercial banks to the retail investors. Accordingly, when the repo rate increases, banks would pass on such increase to the retail investors by way of increasing the lending rates. Such change would in turn increase the borrowing cost whereas any corresponding increase, if any, in the rate of deposits (fixed term / recurring) would benefit the investors."

“Thus, there is a direct correlation between the repo rate as well as the loan and deposit rates offered by the commercial banks would squeeze the liquidity in the market and is a tool to check the rising inflation. Whereas, if the deposit rates go up, the investors are incentivized to consider the deposit instruments as alternatives to other risk averse instruments (such as debt mutual funds, government or corporate deposits, etc)," further added Dr. Suresh Surana.

Shrikant Shrivastava, Chief Risk Officer, IMGC (India Mortgage Guarantee Corporation) said “Now as we have another 35-bps increase in repo rate the EMI’s are expected to go up further by another ~3-5%. As far as loan tenor increase is concerned, I don’t think there is much room for loan tenor increase beyond the 13 years already done till date, due to 190 bps previous increases. Home loan borrowers who have had their home loan original interest rate at 10-11% and initial loan tenors above 25 years would have had no option but to increase their EMI because any attempt to increase their loan tenor would result in loan becoming negatively amortized. Meaning, the original EMI would not be sufficient to cover the monthly interest payable with the existing EMI thereby resulting in the loan principal increasing every month instead of reducing. Most banks have fully passed on the repo rate increase of 190 bps to the consumers of home loans till date. This rate hike of 190 bps has resulted in a loan tenor increase of ~ 13 years for borrowers who had initially opted for 20 years loan period, assuming they had taken a home loan at 6% at the time of home purchase. Alternatively, those borrowers who opted for an EMI increase instead of a loan tenor increase have seen their EMI go up by ~20% already."

Atanuu Agarrwal, Co-founder, Upside AI said “Although inflation seems to be moderating but it still remains above RBI’s cap of 6%. Also, although companies have been passing on some of the higher input costs to customers, subdued margins show that there is still some room for increase in prices. In that context, RBI’s repo rate hike and hawkish tone make sense. These hikes usually pass through to loan rates quicker than deposit rates. However, given robust credit growth, there is pressure on financial institutions to gather deposits which may mean higher rates sooner rather than later."

Mr. Shishir Baijal, Chairman & Managing Director, Knight Frank India said “The RBI has been extremely judicious in their decision to raise repo rate by 35 bps as against the previous revisions, which were much sharper. The move is a balanced approach towards continued economic growth despite the higher than tolerance level of inflation. This hike in the repo was within expectation as the inflation has reduced and is expected to further reduce in the next few quarters, while the concern around domestic economic growth emerges amidst the current global vulnerabilities. Since the rate hike cycle in May 2022, home loan products have become expensive by around 150 bps before today’s hike. The lending rates have risen significantly, especially for the loans linked to External Benchmark based Lending Rate (EBLR) where there has been a 100% transmission of repo rate. Loan products linked to MCLR rate are also up by around 108 bps during this period."

“This hike will further impact EMIs and reduce home affordability. Simply based on the interest rate impact in this rate cycle, the Knight Frank Affordability Index has recorded a cumulative deterioration of an average of 3% across the country. However, as we have seen since the beginning of the rate hike cycle, latent demand has sustained, albeit with some moderation, in cumulative housing sales since the beginning of the rate hike cycle. The 35-bps rate hike by the RBI may be considered moderate in the current context and therefore considered a welcome move," said Mr. Shishir Baijal.

Mr. Anil Rego, founder, and fund manager at Right Horizons, SEBI Registered Portfolio Management Service provider said “The RBI has hiked the repo rates by 50 basis points (bps) thrice, and an off-cycle 40 bps increase in 2022, bringing the rate to 5.9%. The Consumer price index (CPI), which the RBI primarily focuses on during the monetary policy, is showing signs of moderation, dropping to 6.77% in October from 7.41% in the preceding month but remains above the central bank’s tolerance band since the beginning of the year. The GDP growth in the second quarter of the fiscal came in at 6.3%, in line with RBI’s forecast, the federal reserve has signalled a slower trajectory for rate hikes, and Brent crude prices have come down to 80$ per bbl. Considering all this, economists expected the rate hike to be in the range of 25-35 bps, and RBI has hiked the rates by 35 bps to 6.25%, in line with expectations. RBI commentary and announcement is mostly in line with street expectations and thus we don’t see any material impact on the economy from RBI rate hike decision. Inflation is expected to be around 5% in Q1FY24 and 5.4% in Q2FY24, thus repo rate is expected to peak around 6.7% for this rate hike cycle. Government Capex has slowed down in Q2, which is a bit negative however since we are entering into pre-election year, we can see that reversing over the next two quarters."

“The market’s momentum depends on how much the rate is hiked relative to expectations. Surprises generally follow with volatility in the market; however, RBI has hiked the rates hike by 35bps as per the market expectations. When the interest rate rises, it impacts both the economy and the stock markets because borrowing becomes more expensive for individuals and businesses, having a ripple effect across sectors. Higher interest rates mean terminal values are lower as the discount rate used for future cash flow is higher," said Mr. Anil Rego.

“The financial sector has historically been among the most sensitive to changes in interest rates. Typically, during a rising interest rate scenario, the banking sector passes on rate hikes through the floating rate loans while delaying the rate hikes for deposits, benefitting from spreads, and expanding margins. Banks report strong topline growth due to healthy disbursements, higher loan rates, and robust earnings growth on the back of promising advances. A change in stance to dovish going forward by RBI will lead to rally in the banking segment while a prolonged hawkish stance will impact deposit rates and lead to narrowing NIMs, more so for PSBs. Overall, economy seems to be in good shape and a peak rate of 6.7% is not an unusually high number for domestic markets, thus we don’t see any material impact on the stock market but second order consumption impact we will watching closely, especially on the consumption side," further added Mr. Anil Rego.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint.

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Vipul Das
Vipul Das is a Digital Business Content Producer at Livemint. He previously worked for (OneIndia News) and has over 5 years of expertise in the finance and business sector. Stocks, mutual funds, personal finance, tax, and banking are among his specialties, and he is a professional in industry research and business reporting. He received his bachelor's degree from Dr. CV Raman University and also have completed Diploma in Journalism and Mass Communication (DJMC).
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Updated: 07 Dec 2022, 08:44 PM IST
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