Q. I am a 29-year-old front-end software developer, working in Mysuru. I have had a home loan and a car loan on me for the past 3 years. I have noticed that the amount of my loan EMIs have increased in the past 1 year. On inquiry from my bank I understand that this is because of the change in repo rate by the RBI. Can you please elaborate on what is the repo rate and how it impacts loan borrowers like me, and whether there will be further increase in the repo rate and consequently in my loan EMIs?
Repo rate is the interest rate at which the Reserve Bank of India lends money to commercial banks for a short term against the collateral of government securities. Repo stands for repurchase agreement, which means that the banks agree to repurchase the securities from the RBI at a predetermined price and date.
Repo rate is one of the key instruments that the RBI uses to control the money supply and inflation in the economy. By changing the repo rate, the RBI can influence the cost of borrowing and lending in the banking system.
Monetary Policy Committee
The repo rate is decided by the Monetary Policy Committee (MPC) of the RBI, which consists of six members - three from the RBI and three appointed by the government. The MPC meets every two months and announces its decision on the repo rate and other policy measures. The MPC aims to maintain price stability and support economic growth by adjusting the repo rate and other policy tools.
The MPC has not increased the repo rate since February 2023, when it raised it by 25 basis points to 6.50%. Since then, the MPC has kept the repo rate unchanged for two consecutive meetings, in April and June 2023. The main reasons for this are:
- Inflation has eased and moved into the tolerance band: The CPI inflation declined from 6.7% in 2022-23 to 5.1% in March-April 2023, mainly due to lower food prices and base effects. The MPC expects inflation to remain within the target range for the rest of 2023-24, barring any unforeseen shocks.
- Growth has been stronger than anticipated and is holding up well: The real GDP growth in 2022-23 was 6.5%, higher than the RBI's projection of 6%. The MPC expects growth to remain robust in 2023-24, supported by favourable domestic and global factors. The MPC also noted that the output gap has narrowed significantly and that capacity utilisation has improved across sectors.
- The policy transmission is still working its way through the system: The MPC observed that the cumulative increase of 250 basis points in the repo rate since May 2022 has had a lagged impact on various segments of the economy, such as credit growth, investment demand and consumption expenditure. The MPC also noted that the liquidity conditions have been tight and that there is scope for further improvement in monetary policy transmission.
The MPC also decided by a majority of five out of six members to remain focused on 'withdrawal of accommodation' to ensure that inflation progressively aligns with the target while supporting growth. This means that the MPC is not ruling out further rate hikes in the future if inflationary pressures persist or intensify. However, for now, the MPC has adopted a wait-and-watch approach and has decided to keep the repo rate unchanged at 6.50%.
The repo rate has a direct impact on the end users who have taken loans from banks. When the repo rate increases, it becomes more expensive for banks to borrow money from the RBI. This leads to an increase in the interest rates that banks charge on their loans to customers. Conversely, when the repo rate decreases, it becomes cheaper for banks to borrow money from the RBI. This leads to a decrease in the interest rates that banks charge on their loans to customers.
Impact of Repo Rate
Different categories of borrowers are affected differently by changes in repo rate. Here are some examples:
Home loan borrowers: Home loans are usually long-term loans with fixed or floating interest rates. If the repo rate increases, banks may increase their lending rates for new customers, making home loans more expensive. Existing customers with floating rate loans may also see their EMIs go up as banks pass on the higher cost of funds.
However, if the repo rate decreases, banks may reduce their lending rates for new customers, making home loans more affordable. Existing customers with floating rate loans may also see their EMIs go down as banks pass on the lower cost of funds.
Auto loan borrowers: Auto loans are usually short-term loans with fixed interest rates. If the repo rate increases, banks may not change their lending rates for existing customers, but they may charge higher rates for new customers, making auto loans more expensive.
However, if the repo rate decreases, banks may not change their lending rates for existing customers, but they may charge lower rates for new customers, making auto loans more affordable.
Personal loan borrowers: Personal loans are usually unsecured loans with high interest rates. If the repo rate increases, banks may increase their lending rates for both existing and new customers, making personal loans more expensive. However, if the repo rate decreases, banks may reduce their lending rates for both existing and new customers, making personal loans more affordable.
The repo rate affects the deposit rates that banks offer to their customers. When the repo rate increases, banks tend to increase their deposit rates to attract more funds from customers. This helps them to maintain their liquidity and profitability.
Conversely, when the repo rate decreases, banks tend to decrease their deposit rates to discourage excess funds from customers. This helps them to reduce their cost of funds and pass on the benefit to borrowers.
Therefore, as an end user, you should keep an eye on the repo rate movements and understand how they affect your loan and deposit rates. By doing so, you can make informed decisions about your borrowing and saving needs.
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Note: This is for informational purposes. Please speak to a financial advisor for detailed solutions to your questions.