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EduPristine>Blog>Repo rate cut to 7.75% before the impending budget reforms

Repo rate cut to 7.75% before the impending budget reforms

January 16, 2015

Build-up to the interest rate-cut

There has been wide-spread speculation in reference to the rate-cut for a while now. The constant inflation & the controlled fiscal deficit go a long way in delimiting the pressure on the import bill. India has managed to increase its forex reserves to the bare optimum. And the CPI for the month hasn’t crossed 5%. The pressure-bells have been ringing on the RBI honcho owing to widespread calls for the rate cut. Well, there’re signs, but Raghuram Rajan maintained a strong front even as India Inc. calling for it in large numbers. From Arundhati Bhattacharya (SBI) to Anshu Jain (Deutsche Bank) & Motilal Oswal had called for rate cuts. You could say that the timing of the latest announcement revising the rate to 7.75% is spot-on. Just before Mr. Arun Jaitely takes center stage & announces our next fiscal budget reforms, the market has struck a chord with 28 out of 30 stocks from SENSEX rallying up.

The SENSEX touched 28k, and the 600+ point jump is one of the biggest jumps in the stock market in recent times. We have to see whether we will see impending significant reforms from the government post-budget as the market calls for a dire need with some upheaving changes. In recent news, the World Bank had bet on India crossing China, in growth numbers by 2020. Well, it’s a longshot to sustain this growth. As, barring India, none of the emerging countries seem to sustain 6+ percentage GDP growth in the long rain. Only China is currently seemed to leverage the 8% barrier.

Why do central banks rely on rate-cuts?

For the central bank (RBI), the OMOs (Open market operations) are the key to control a nation’s economy. Divestment by selling stake in PSUs & manipulating rate-cuts are some ways by which a central bank can try to infuse liquidity in the market.

How rate-cuts affect the common man?

The reserve bank of India has cut the repo rate by 25 basis points to 7.75%. This is the rate at which the central bank lends money to commercial banks. And this cut-down trickles down to the consumers. As the rate-cut is passed on by banks eventually lowering their interest rates for home loans etc., this spells as good news for the common man like you & me. Your EMIs are set to ease a notch down. For example, a home loan of Rs 50 lakh for tenure of 20 years, charges an EMI of Rs 51609 at 11%. If the interest rate falls by 25 basis points to 10.75% the EMI stands reduced to Rs 50,761. It is probably the right time to take a home loan from your bank because of the lower rate of interests.

The banks will pass on the benefit of falling interest rate to borrowers, which will bring down the EMI on the floating rate home loans. If your bank is not lowering interest rates going forward, you may consider transferring your outstanding loan to PSU banks. The average size of a home loan is 20 years and that is a long period with many cycles of rate cuts & rate hikes. Rate cut by the RBI does not directly imply a rate cut by commercial banks. Every bank can decide (within their own limits) on what their lending & deposit rates should be. Though life may be better for borrowers, your investments may see some adverse impact of lower rates.

Fixed deposits interest rates may also see cut in interest rate almost immediately. Banks have anticipated this change in cycle and have reduced interest rates on fixed deposits by 25 bps in select baskets in the last month quarter itself. You can also lock in current interest rates by opting for three and five year fixed deposits before the banks take a decision.

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