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Understand what a recent hike in Repo rate & Cash Reserve Ratio means to us…

financial planning - interest rates

In a surprise announcement, yesterday, the Reserve Bank of India hiked a ‘repo rate’ by 40 bps now. Now, it is 4.40%. Whereas ‘cash reserve ratio’, i.e. CRR has been increased by 50 bps making it 4.50% now.

Other key policy rates such as ‘reverse repo rate’ has been kept at is so it remains the same as 3.35%.

The standing deposit facility rate is now at 4.15% while the marginal standing facility rate & bank rate stand at 4.65%.

After experiencing lower interest rate regime for over 3 years, this move is important to consider.

Well, let’s understand first what are repo rates & cash reserve ratio?

Repo rate is the rate of interest at which the RBI lends money to commercial banks. When the rate is low by RBI, commercial banks in turn can provide loan at cheaper rate. Now when it has been increased, it will further propel commercial banks to raise their interest rate offerings.

Whereas, ‘cash reserve ratio’ is the commercial bank’s share of deposit which needs to be maintained at RBI. Since it has been increased too, it will put further pressures on commercial banks.

What made RBI to take this decision?

We all have been experiencing the effect of rising food prices in our daily life since last 7-8 months.

Talking in economic sense, following are the reasons behind this decision-

  • As the above reason goes, globally, inflation is rising at alarming speed.
  • Global food prices have risen at high in March. Jump in prices of edible oil, fertilizers, have also put pressure on the inflation indices.
  • Crude oil prices continue to hover around $100 per barrel. It has wide impact globally.
  • Geopolitical tensions, export bans have further increased input costs of non-food manufacturers making many items at high cost.

Due to the above reasons, the rate hike has been announced with an intention to cut inflation that has been above the RBI’s upper tolerance limit of 6% for the last 3 months.

Retail inflation based on ‘Consumer Price Index’ has jumped at record 6.9% in March 2022.

How will it impact you?

Any change in key policy rates have direct & indirect impact on all of us.

Now, lets see, how it is applicable to us from different ways….

If we have loan EMIs to pay:

We all need to take loans for some or the other reasons. When you opt for loans, you attract EMIs to pay.

As explained, this move by RBI will put pressure on commercial banks to increase their lending rates.

In the year 2019, all banks including State bank of India were mandated to lend only at an interest rate linked to external benchmark, such as Repo rate or treasury bills yield.

As a result, monetary policy transmission by banks has gained traction.

Now, as the repo rate has been increased, it is the indication to increase lending rates by commercial banks.

This in result will increase your monthly outflow towards loan EMIs. Many of us have ongoing home loans, EMIs of which will increase respectively.

So, please be mindful while spending, opting for loans & about your spending patterns.

When we have investments in Mutual funds, bank deposits:

Many of us have investments in debt & equity mutual funds. If you have invested in debt funds for the medium to long term period, then your debt fund holdings will have impact in inverse way.

Debt funds have inverse relationship with interest rate hikes, when they move up, returns from debt funds go down.

So, get your portfolio reviewed if you are heavily invested in such funds.

Talking about equity markets, it tumbled over 1307 points upon this news of rate hike yesterday i.e. 4th May 2022.

Businesses across all segments will have direct & indirect impact of this rate hike as costs related to loans will be higher.

When it comes to bank deposits, we have seen lower interest rates since a few years. People who are quite dependent on interest income especially senior citizens were in real pain.

But, good news for them now! Bank deposit rates have direct co-relation with RBIs interest rates like loan interest rates.

With the hike in repo rates, banks will increase deposit rates now to attract liquidity with them.

So, we can look forward to higher deposit rates.

Impact on our cash flows:

We all have our own respective cash flows filled with household expenses, loan EMIs, etc. Since inflation is on the rise, we need to keep aside more for our household expenses like food, vegetables, etc.

Loan EMIs will face a hike too, so count on your ongoing EMIs. Talk to your respective bank about likely increase in loan EMI outgo.

Since these mandatory expenses will cover majority of your cashflow sheet now, you will be left with lesser money for your discretionary expenses like hoteling, shopping etc.

We need to be mindful about it going forward on spending patterns that we have, expenses we incur.

The repo rate hike will have medium to long term impact on our personal finances. We need to keep this in mind & act thoughtfully!

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