PremiumThe Reserve Bank of India (RBI) on Friday cut policy rates and extended the moratorium period till August to give borrowers facing a cash crunch some respite. But the move may not help all borrowers for three reasons: the cut will immediately benefit only those whose loans are linked to the repo rate, new borrowers may find it difficult to get a loan as banks have tightened lending policies and the moratorium will add to the cost of the loan in the long term. Depositors will suffer and so will debt mutual fund investors as long-dated funds may not gain the way they normally do after a rate cut, and short-term funds will see their returns fall.
Here is a detailed analysis of what the policy rate cut means for the borrowers, depositors and investors.
RBI’s moves may give twin relief to some. One, the repo rate cut by 40 basis points (bps) will bring down the interest rate on loans linked to external benchmarks. Two, the extension of the loan moratorium facility till August will bring immediate relief.
Repo-linked loans: If you took a loan after 1 October, you can expect your EMIs to go down by 40 bps whenever your next reset triggers. One bps is one-hundredth of a percentage point.
Effective 1 October 2019, all new retail loans were linked to an external benchmark and most banks have chosen the repo rate. RBI has made it mandatory for banks to reset home loan interest rates under the external benchmark at least once in three months.
“The transmission of the latest rate cut will be faster in case of loans linked to repo rate. However, the transmission of rate reduction will be incomplete for new borrowers if the banks simultaneously increase their spread or credit risk premium during the interest rate reset," said Naveen Kukreja, CEO and co-founder, Paisabazaar.com.
New borrowers will be able to get loans at lower rates as and when banks implement them. However, whether or not you will get loans, with banks tightening their lending policies in the current environment, is another question. “The cut in repo rate will bring immediate relief to RBI since about ₹8 trillion is parked with it and so RBI will save on interest payments. But for new borrowers, this cut may not mean much given the fact that banks and NBFCs (non-banking financial companies) are shying away from lending operations. This despite the fact that consumer demand is high," said Raj Khosla, managing director, MyMoneyMantra.com, a financial services provider.
MCLR-linked loans: If your loan is linked to the marginal cost of funds-based lending rate (MCLR), the rate cut may not mean a fall in EMIs immediately.
Under the MCLR regime, the majority of lenders have an annual reset clause for home loans. Therefore, how much and when the interest rate on MCLR-linked loans would fall will depend on your bank’s reset date and how the cost of funds reduces for it. “MCLR is linked to deposit rates and is decided by the banks themselves. Hence the movement in MCLR is not always direct and immediate. To protect their margins, banks will be slow to change MCLR. Also, the reset period in MCLR loans is longer than repo-linked loans," said Gaurav Gupta, CEO, Myloancare.com.
Moreover, if you have a loan from an NBFC or housing finance company (HFC), you may not benefit as these entities have not been mandated to the external benchmark regime. “The availability of funds and the cost of funds for these lenders is also a challenge and, hence, they may not be able to reduce rates," said Gupta.
Loan moratorium: RBI has extended the moratorium facility by another three months till August but remember that it will come to bite you in the long term even if it gives you short-term relief. This is because during the moratorium period, interest will continue to be levied on the outstanding loan. Once the moratorium period gets over, the interest accrued during the period will get added to the principal outstanding and, hence, increase the overall loan amount (read more atbit.ly/3cW46TY).
“The three months’ extension of the moratorium will be welcomed by borrowers struggling with liquidity problem," said Adhil Shetty, CEO and co-founder, BankBazaar.com, an online marketplace for financial instruments. “While it is expected that there will be no credit score impact, borrowers should continue to do their monthly checks to be aware of their standing. Borrowers must also understand how the added interest impacts them and be prepared with cash in hand over the next year to prepay their dues to bounce back from the additional debt," added Shetty.
The cost of taking the moratorium benefit will depend on your remaining loan tenure, the rate of interest and the loan amount. The higher the rate of interest, the higher will be your cost of moratorium. Similarly, the longer the tenure left, the more will be the moratorium burden.
The repo rate cut will also result in a fall in the interest rates on fixed deposits (FDs). “Banks are sitting on liquidity with large deposits in savings accounts and FDs. They are paying interest but not earning interest. This mismatch can’t continue for long," said Aditya Mishra, CEO, Switchme.in.
Banks have already lowered their interest rates. State Bank of India (SBI) cut its interest on FDs by 20 bps on 12 May. Its one-year FD offers an interest rate of 5.50% a year. Falling interest rates pose difficulty for senior citizens as some of them rely on the interest earned on FDs for regular income. But some banks including SBI have launched special FDs for senior citizens offering higher interest rates (read bit.ly/36jz4TM).
This time around, long-dated debt funds may not see large gains, while short-dated funds will see a fall in returns due to yield reduction. Typically, the immediate effect of a rate cut is a jump in the net asset values of debt funds. This is because the prices of bonds rise when interest rates fall. The extent of the jump is given by a measure called modified duration. For example, a fund with a modified duration of 2 will see a roughly 2% jump for every 1% cut in rates. Gilt (government securities) funds that tend to invest in long-dated bonds, typically, see the biggest gains from rate cuts. However, this may not happen this time due to bond yields failing to react in a big way.
In fact, the rate cut is likely to lower returns on categories such as overnight, liquid and ultra short-term funds whose returns are connected to yields in the short-term debt market. These yields tend to drop when interest rates are reduced. Also, the impact of changes in the values of the bond on the returns from these funds is limited.
But will the rates fall further? Debt fund managers are divided. “It remains to be seen what measures RBI takes to ensure smooth absorption of government borrowing," said Rajeev Radhakrishnan, head, fixed income, SBI Mutual Fund. Government borrowing tends to exert upward pressure on yields in the debt market. Earlier this month, the Centre announced an economic package of ₹20 trillion to revive growth.
However, Mahendra Jajoo, chief investment officer (CIO), fixed income, Mirae Asset Mutual Fund, expressed confidence about rates coming down further. He also dismissed concerns about the jump in food inflation to 8.6% in April that the RBI governor alluded to in his statement.
So what should you do? “Even before the rate cut, short-term funds and banking and PSU debt funds looked attractive for investors. That continues to be the case for someone with a time horizon up to three years. If you’re only in liquid funds, allocate some part of the money to these categories," said Mrin Agarwal, founder, Finsafe India Pvt. Ltd, and co-founder, Womantra.
Agarwal also recommended that investors should avoid funds that have high yields on account of credit risk. Given the uncertainty in the overall economy due to covid-19, a low-risk approach tailored to your goals can work better than aggressive bets on either credit or duration (long-dated bonds). The latter have rallied considerably over the past year, but they are extremely sensitive to changes in interest rates.
Consider the impact the policy rate cut might have on you before stitching up your borrowing and investment plans.
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