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Impact Of Increasing Repo Rates Research Team | Posted On Wednesday, August 01,2018, 07:53 PM

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Impact Of Increasing Repo Rates




RBI has increased the repo rate by 25 basis points for the second time in a row. On August 1st 2018, in its third bi-monthly monetary policy review of 2018-19, RBI increased the repo rate and it now stands at 6.5%. Earlier on June 6th 2018, RBI had hiked the repo rate by 25 basis points and it stood at 6.25%. For the first time since October 2013, repo rate has been increased at successive policy meetings.

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Impact of Increasing Repo Rates


Repo rate or repurchase rate is the rate at which RBI lends money to commercial banks, should they face scarcity of funds. An increase in the repo rate means banks borrow money from RBI at higher rates. To absorb the increased cost of borrowing, banks charge higher interest rates to borrowers (people who avail loans). Interest rates on home loans, car loans, and personal loans should increase with a repo hike. Hence, the increase in repo rate is transferred to the common man.


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Adverse effects of the increase in repo rates:


Consumer’s borrowing cost increases: To absorb the increased cost of borrowing from the RBI, banks charge higher interest rates to borrowers. Interest rates on home loans, car loans and personal loans will increase significantly. Hence, the increase in repo rate is transferred to the common man.

Risky investments are put on hold: People will look to deposit money in bank FDs as many banks will hike deposit rates. This is good news for senior citizens and people who live on interest income from bank FDs. Not so good news for mutual funds and stocks as many citizens avoid risky investments. People prefer the safety of bank FDs when repo rates go up.

The economy will slow down: Due to rising interest rates, borrowing from commercial banks slows down. Consumers postpone availing home loans and car loans as purchasing of houses and cars are postponed. Let’s say you want to purchase a car. The interest rate is 10-12% a year. Now the repo rate goes up and banks hike interest rates on car loans.  Will you buy the car now or wait for interest rates to fall? If a large number of consumers postpone purchases of houses or cars, there will be a slowdown in infrastructure, auto industry and of course the banking sector. This will dampen the economy.

Home loans will become costly: With the repo rate hike, banks will increase home loan interest rates. This is definitely bad news for citizens looking to avail home loans. Existing borrowers may not find interest rates going up immediately. Even if banks MCLR comes down in the same month, the borrower feels the effects only after 6 months or a year. The bank will not increase home loan EMIs, but will extend the tenure of the home loan, keeping EMIs constant. This will increase borrower’s interest costs.  


SEE ALSO: Will Banks Raise Interest Rates?


Positive effects of an increase in repo rates:


Interest rates on FDs and Small Savings Schemes will increase: As repo rates rise, banks offer higher interest to depositors. Therefore, an increase in repo rates will not only hike interest rates on loans, but it will also lead to a hike in interest offered on Fixed Deposits, Small Saving Schemes and so on. This will benefit senior citizens who live on interest income. SBI has already increased fixed deposit rates by 10 basis points on July 31st 2018.

A measure to curb inflation: With higher interest rates, consumers postpone borrowing. Spending is curbed. With money sucked out of the economy and less liquidity, inflation is brought under control. How? Lesser money chases equal or more goods, pushing inflation down.


Why is inflation rising?


Trade wars: With the U.S. and China fighting a trade war, the World suffers. As tariffs barriers are imposed between Nations, imports get costly.

Increasing fuel prices and the weak Rupee: Even a single dollar rise in crude oil prices, increases our import bills by Crores of Rupees. This results in increase in the prices of petrol and diesel. Diesel being the main fuel used in transport of goods, transportation costs rise. This is reflected in the final prices of goods and services. As prices of goods and services increase, so does inflation.


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