RBI Increases Repo Rate by 40 Basis Points; What This Means For You

The repo rate is considered a key tool for the Reserve Bank of India to keep inflation under control

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In an unscheduled announcement on Wednesday, the Reserve Bank of India (RBI) governor Shaktikanta Das said the central bank held an off cycle-meeting amid high inflation and voted to increase the repo rate by 40 basis points to 4.40 per cent.

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The reasons cited were rising inflation, geo-political tensions, high crude oil prices and shortage of commodities globally, which have impacted the Indian economy. It has also been decided to increase the Cash Reserve Ratio (CRR) by 50 basis points to 4.50 per cent. "CRR hike can suck out liquidity to the tune of Rs 83711.55 crore," the governor said.

The move shocked the stock markets. After the rate hike, Sensex slipped 1,306.96 points to end at 55,669.03 and Nifty tanked 391.50 points to close at 16,677.60.

May 2020 was the last time the repo rate was cut. It remained unchanged since then. Further, the repo hike will come into effect immediately and the CRR hike will be effective from midnight of May 21.

"MPC (Monetary Policy Committee) judged that the inflation outlook warrants an appropriate and timely response through resolute and calibrated steps to ensure that second-round effects of supply-side shocks on the economy are contained and long-term inflation expectations are kept firmly anchored," the governor said.

What is Repo Rate?

Repo means ‘Repurchasing Option’ or ‘Repurchase Agreement’. This is an agreement in which banks provide eligible securities to the RBI while availing overnight loans.

Repo rate is the rate at which RBI lends money to commercial banks whenever they approach the central bank to borrow money. The RBI periodically decides whether to hike/reduce the rate or leave it unchanged. The repo rate is considered a key tool for the RBI to keep inflation under control. Basically, whenever there is inflation, RBI increases the repo rate as this acts as a deterrent for banks to borrow from the central bank. This reduces the money supply in the economy, thereby controlling inflation.

What this move means for you

This sudden move by RBI is being looked at as a dampener for those going for home loans, personal loans and auto loans. For, the decision is likely to make banks increase interest rates on loans.

“Inflation rates in India have been beyond the RBI’s upper band of tolerance, which is 6 per cent, and the rationale of the move makes sense – the hope being that home loans would not get impacted,” said Dr. Niranjan Hiranandani, vice chairperson, NAREDCO and managing director, Hiranandani Group.

Reportedly, this is also not good news for existing borrowers as most home loans are on a floating rate basis. According to RBI, all floating rate home loans taken after October 1, 2019 are linked to an external benchmark and most banks have chosen the repo rate as their external benchmark. This means the current repo rate hike will mostly mean a hike in loan interest rates. And, as the banks start increasing interest rates on loans, the EMIs will also go up. However, this may be good news for short-term fixed deposit (FD) investors as they may benefit. Experts believe that in these situations, usually the short to medium-term interest rates are likely to increase first.