Explained: RBI hikes the repo rate by 25 bps to 6.5 per cent. What does this mean?

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The Reserve Bank of India (RBI), on Wednesday (February 8) raised its key repo rate by 25 basis points (bps) and said that the country’s core inflation remains high. This comes after the central bank raised its key benchmark interest rate by 35 basis points (bps) in December, following a monetary policy review. The recent decision by RBI Governor Shaktikanta Das-headed Monetary Policy Committee (MPC) might make external benchmark-linked loans costlier. 

What is the repo rate and what does it affect?

The repo rate is the interest rate at which the central bank of a country, in this case, the RBI, lends money to commercial banks if they fall short of funds. This indirectly affects the interest rates of home loans, car loans and so on. It is also used by monetary authorities to control inflation. The hike will also directly have an impact on both bank depositors and new loan borrowers as the banks raise their interest rates on consumer loans. 

What is the current repo rate?

The announcement, on Wednesday, marks the sixth consecutive rate hike since May 2022. Additionally, the RBI has also increased the repo rate by a cumulative 250 basis points, which took the key interest rate to 6.50 per cent.  

The decision to raise the repo rate

In its first decision since the announcement of the Union Budget 2023, the RBI’s policy panel with a 4:2 majority announced the recent hike. As per media reports, MPC members Ashima Goyal and Jayanth Varma voted against the increase and Shashanka Bhide, Rajiv Ranjan, Michael Debabrata Patra and Shaktikanta Das voted in favour of the hike. 

Additionally, the MPC also retained its stance on the withdrawal of accommodation to ensure that inflation remains within the target while supporting growth by the same majority. Notably, the increase was in line with what most analysts expected. 

How will this affect consumers?

In the upcoming months, since the repo rate is hiked banks will now have to pay higher interest to the RBI which in turn would burden the retail and corporate borrowers of banks as the interest rate on loans taken from the banks would also increase. Therefore, loans including home, auto, personal and so on, are expected to become at least one to two per cent costlier.

Additionally, as loan borrowers may have to pay more interest it can also lead to higher equated monthly instalments (EMIs) or monthly repayments. An SBI official also told the Indian Express that deposit rates are also expected to witness some changes after the announcement. 

According to experts, what matters is the time frame that one intends to repay the loan as the RBI is expected to take a break from its rate hike cycle in the upcoming months. Today’s increase might be the last hit to the loans. “The silver lining is that the inflation is likely to moderate in 2024-25 and the RBI seeks to bring down the inflation to its target levels – within four per cent”, said Adil Shetty, CEO and Co-founder of BankBazaar, as per Financial Express. 

He added, “It will make retail loans such as home, auto, and personal loans, among others, costlier, and borrowers will have to be ready for higher monthly EMIs or tenor extensions, or both,” in the context of the recent hike in repo rate. Therefore, one of the things he recommended was increasing EMI once a year by five per cent, which he says would pull your tenor back by a few months and repeat if required next year and make this an annual exercise. 

According to Shetty, a 20-year loan can be repaid in 12 years if you pre-pay five per cent of the loan balance once a year and depending on your situation you could choose to go fast or slow. However, since home loans are low-cost for most, it makes sense to repay slowly while balancing it with investing needs. The markets have returned 12 per cent over the long term and the cost of a home loan with tax deductions may be five to seven per cent a year, he added. 

Speaking about the timeframe in which you intend to repay the loan, the BankBazaar CEO gave an example and said, if your intention was to repay a 20-year loan in 10 years but the rate hikes have taken your tenor to 25 years. In this case, ensure that for the next 10 years, you pay back at least 10 per cent of the loan through a combination of EMIs and pre-payments, which he says would keep you on track for your goal. 

It is also noted that while the change in repo rate may not have an immediate effect on existing home loan borrowers as their interest rates may be fixed for some time, however, the same cannot be said for new home loan borrowers or those who have taken a floating rate loan. Therefore, one can also consider switching from a floating rate loan to a fixed rate loan which could protect them against further hikes, as per Financial Express. 

RBI’s growth projection 

The real GDP growth for 2023-24 is projected at 6.4 per cent with Q1 at 7.8 per cent, Q2 at 6.2 per cent, Q3 at six per cent and Q4 at 5.8 per cent. The MPC had also previously slashed the GDP forecast for the fiscal year 2023 to 6.8 per cent in December after the policy review from the previous estimate of seven per cent. The RBI governor also said that the real GDP growth is estimated at seven per cent in 2023 and that the Indian economy remains resilient. 

However, the outlook is clouded by “continuing uncertainties from geopolitical tensions, global financial market volatility, rising non-oil commodity prices and volatile crude oil prices”, said Das.

What did the RBI say about inflation?

During his address, Das said that the core inflation remains “sticky” or stubbornly high. He added, “Looking ahead, while inflation is expected to moderate in 2023-24, it is likely to rule above the 4.0 per cent target.” Last year inflation had soared as high as 7.79 per cent in April, which prompted a series of hikes by the RBI in a bid to control it. 

“The global economic outlook doesn’t look as grim now as it did a few months ago, growth prospects in major economies have improved while inflation is on a descent though inflation still remains well above the target in major economies,” said the RBI governor. He added that unprecedented events in the past three years have put monetary policy across the world to the test. 

“Emerging market economies are facing sharp tradeoffs between supporting economic activity and controlling inflation while preserving policy credibility,” said Das. This time around, the central bank has lowered its inflation target for FY23 from 6.7 per cent to 6.5 per cent which is still above its 4.0 per cent goal. While the inflation for FY24 is expected to be 5.3 per cent, said the RBI.  

How did the market respond to the announcement?

Indian shares held on Wednesday after the widely expected smaller interest rate hike delivered by the central bank. As the market neared closing time, the indices overall soared as Nifty gained 0.85 per cent and Sensex 0.63 per cent. Meanwhile, the Nifty 50 index jumped 150 to close at 17,871 while the S&P BSE Sensex rose 377 points to end above 60,600, at 60,633, as per the Mint. 

When is the next MPC meeting?

The next meeting of the MPC is scheduled for April 3, 5 and 6, 2023

(With inputs from agencies) 


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