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.
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.
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 Read: Highest Recurring Deposit Interest across 44 banks
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.
We discuss how rate cuts by RBI impacts your investments and what should you do about it.
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:
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.
Also Read: All about PPF, Senior Citizen Saving Scheme & Sukanya Samriddhi Account
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.
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.
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.
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.
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.
As I write, following banks have announced lending base rate cuts
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!
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View Comments
RBI should not cut Repo rate so fluently as they cut in year 2015, its 4 times in a year and badly effect to Senior citizons, who are basically dependent on intrest of Fixed Deposits as their regular income.
Intrest on Fixed Deposits in December 2014 was 9% and in Sept 2015 its fall down to 7.25%. Really a big impact in just 9 months of Time.
Before taking a big decision like cut in Repo rate we should take care for all the segments, Now Senior Citizens are badly effected by this Repo rate cut.
I totally agree with your comments Shikha. If you see the overall impact of rate cuts it's the savers who loose and borrowers who gain. But unfortunately due to functioning of Indian banks savers loose much more as the deposit rates have already come down by more than 2% in last 1 year while the lending rates have hardly come down by 0.5% to 0.75%.
About the positive impact on home & auto sector I really doubt because such low reductions hardly impact your EMI. If you take home loan of Rs 50 lakhs and the rate reduction happens from 10.5% to 10% the monthly saving in EMI is Rs 1,650. This is not going to impact your decision to buy a Rs 65 Lakh house :)
I am more worried about Government looking to reset interest rates on Small saving schemes like PPF, Senior Citizen Savings Scheme, etc under pressure from banks.