RBI (Reserve bank of India) has cut the Repo Rates by 0.25% (25 basis points) from 6.25% to 6.00% in its latest monetary policy presented on April 4, 2019.
In case you were wondering what Repo rate means, Repo rate is the rate at which the RBI lends money to banks. So if Repo rate comes down so does the overall interest rates.
Also Read: Historical Repo Rates in India
As this happened all the newspaper and social media was all gung-ho that EMIs would come down. But its not that simple. We tell you the details below.
Who Benefits from Rate Cuts?
There was too much pressure from government, industry and investors on RBI governor to cut rates. But the question is who benefits the most from these cuts? The answer is Banks and Lending Institutions. And here is an example to prove the point.
Take SBI, the biggest bank has cut its base rate (the lowest rate at which the bank can lend) just by 0.3% in 2015. It was 10% at the start of 2015 and they cut 0.15% on April 7 and additional 0.15% on June 2.
As for the interest rates on Fixed Deposits are concerned there has been a significant cut. SBI used to offer 8.5% for 3 to 5 Year fixed deposit at the start of 2015. As of today, this rate has come down to 7.25% for the same tenure of FD. A cut of 1.25% from beginning of 2015.
To summarize in last 9 months, RBI has cut repo rate by 0.75% while SBI has cut its base lending rate by 0.3% and deposit rate by 1.25%. The story is similar across banks.
This in turn has increased the spread between the deposit and the lending rates. The more the spread is the more money banks make. The problem is all banks operate almost like cartel and do not pass on rate cuts to borrowers.
Also Read: 22 Hidden Charges in Saving Bank Account
This problem has been stated by RBI too when it says – Median base lending rates of banks have fallen by only about 30 basis points, despite extremely easy liquidity conditions.
I think RBI has done its part and now it’s time government and industry put pressure on banks to pass on the interest rate cuts in right spirit to their borrowers. Until this happens the benefit of lower interest rate would not be passed on to business and to the economy.
Who loses from Interest Rate Cuts?
Rate cut is especially bad for investors who invest in fixed income products like fixed deposits, recurring deposit, etc. Unfortunately this impacts senior citizens who mainly depend on interest income for regular income. As can be seen from SBI, banks act evil by cutting deposit rates very aggressively.
Also with pressure from banks, government is planning to cut interest rates on Small Saving Schemes like PPF, Senior Citizen Schemes, Post Office Deposits, Sukanya Samriddhi Accounts midyear. Ideally the interest rates on small saving schemes are reset only at the start of financial year.
Impact on Investments:
We discuss how rate cuts by RBI impacts your investments and what should you do about it.
Fixed Deposits (FD):
This is most popular saving/investment in India. As you can see above Rate cut is always bad for FD investors as the interest offered by banks would go down significantly and hence your returns.
What you can do?
Here are the things you can do to lock higher interest rates:
- Banks take few days to cut their deposit interest rates. If you had planned to invest in FD go ahead and do it before the rates come down.
- In case you do not have that kind of money but still want to lock-in high rates – Recurring Deposit (RD) is for you. Start your RD now and you can lock the high interest rate for the entire tenure of RD. Most banks offer RD deposits up to 10 Years.
- Look for FD from companies – Some NBFCs, Housing finance companies and manufacturing companies have FD schemes. They generally offer higher interest rates than banks and they have still not cut their FD rates. So it’s good time to look into the available options.
Small Saving Schemes:
The interest rates on Small Saving Schemes like PPF, Senior Citizen Schemes, Post Office Deposits, Sukanya Samriddhi Accounts are revised at the start of every financial year and is linked to yields on Government Bonds. But under pressure from banks Government is looking to revise it midyear. So investors in these schemes would get lower interest rates.
A decrease in interest rate increases the price of bond, which gives capital gains to investors. So in case you feel that the interest rate is going to go down further, it might be good idea to invest in bonds/NCDs.
Tax Free Bonds:
NTPC had issued its tax free bonds a few days ago, which was over-subscribed on the first day itself. PFC too is offering its tax free bonds from October 5 with similar interest rates. There are other companies in queue with their tax free bonds. If you wanted to subscribe to these bonds go ahead and invest in PFC tax free bonds. The next series of bonds from other companies would have even lower interest rates. As stated above lowering of interest rates would give capital appreciation.
Debt Mutual Fund:
Interest rate change impacts longer term debt funds more than its short term debt counterparts. So again if you feel that interest rates are going down invest in long term gilt/debt funds. You can reap good capital gains when the next few cuts happen.
Also Read: Tax on Equity and Debt Mutual Funds
In most case lower interest rate scenarios is better for business as most companies have to service a lot of debt. If the interest rate goes down the cost incurred in paying interest on those debts also comes down and hence higher profits. Higher profits mean higher stock prices and hence higher SENSEX & NIFTY. Keep in mind, short market reactions to these rate cuts are good for traders but long term investors have no impact. Equity returns depend on lot of factors other than interest rates.
Impact on Rate Cut on Currency:
Indian Rupee has been lately loosing value against US dollar. Due to rate cuts, amount of foreign currency coming to India for higher yields would be lower. This in turn would put more pressure on rupee and will depreciate further. However interest rates are not the only factor for currency fluctuations but one of the major factors.
Impact on Loans:
Most of newspapers and TV new channels have started shouting “EMI would come down”. But the truth is in most case EMI would remain same and your tenure of loan would reduce. We discuss the impact on new loan Vs existing loans.
Also Read: Home Loans: HFC vs Banks? Choose Wisely
If you are looking for new loan, interest rate cut is a blessing. A rate cut increases loan affordability or lowers EMIs. Below is the chart which shows how much you can borrow at different interest rates keeping EMI fixed at Rs 50,000.
As you can see as the interest rates decrease, the quantum of loan that you can borrow goes up. Hence you can buy a higher priced asset!
Secondly if your loan is same, the EMI decreases.
For most of people paying EMIs this small rate cut would not change much. Most of banks/financial institutions do not pass the cut to existing customers! Even if you get the benefit it’s not in terms of lowering of EMIs but in terms of reducing of tenure. The chart below shows the quantum by which your tenure would decrease with reduction in interest rates.
As can be seen the rate cut impacts longer tenures much more.
Rate Cut Announcement by Banks:
As I write, following banks have announced lending base rate cuts
- SBI has cut base rate by 0.4% to 9.3% with effect from October 5, which is now lowest among all banks. SBI will also be reducing its deposit rates further by 25 basis points.
- Andhra Bank was the first to announce base rate cut by 25 bps to 9.75%
- Bank of India cuts base rate by 25 basis points to 9.70% effective October 5
- Axis Bank Cuts Base Rate By 35 bps To 9.5% w.e.f October 5
We expect similar announcements from all banks. Expect further cut in deposit rates.
Interest rates are powerful factors which influence our personal finance in terms of return on investment, loans and economy. Knowing its impact on various instruments would help you in better planning!