The Reserve Bank of India (RBI) on Wednesday increased policy rates by 25 bps to 6.50 per cent, in the second consecutive rate hike by the central bank.
Any change in the repo rate impacts not only the economy, the banks sector and industry but also has a bearing on your finances. Here's how the latest hike in interest rate will impact your loans and investments.
If you have borrowed money from the bank or are planning to do so in the future, the repo rate hike could be bad news for you.
A hike in repo rate means that banks will have to pay a higher rate of interest on their borrowings from the RBI, which they are likely to pass on to their own borrowers. This means you will likely end up paying more for the loan you've taken, or plan to take, from your bank.
Banks do this by increasing their marginal cost-based lending rate (MCLR) and base rate. Since the start of the year, many banks have been increasing their MCLR.
After the repo rate hike on Wednesday, at least four lenders - HDFC Bank, Kotak Mahindra Bank, Karnataka Bank and Union Bank of India -- has hiked their MCLR by 5-20 bps. (See chart: How a 25bps hike in MCLR impacts home loan EMIs)
The interest rates on bank fixed deposits are among the first to respond to a change in repo rates. So if you're planning to put some money in a fixed deposit and the repo rate rises, you stand to gain. The vice versa applies in case the repo rate falls. However, your existing FDs will continue to bear the interest rate at the point that you investment.
This principle also applies to corporate bonds.
Recently, State Bank of India (SBI) hiked its deposit rates by 5 to 10 bps. The hike will translate into higher interest earnings for cutomers opening fixed deposits with the bank.
However, a repo rate hike will adversely impact those who've invested in long-term debt funds. This is because the investments made by such funds will have to start matching the yields offered by newer instruments. And that can only happen when their prices move south.
As evident from the decline in their stocks the past two days, the rate hike isn't good news for banks.
The RBI's move will mean that banks would have to pay a higher interest on their borrowings from the central bank, resulting in an increase in their cost of funds.
Moreover, the increasing interest rates will deter likely borrowers, who might decide to wait for a rate cut before taking any loan from banks. As interest from loans is a major source of income for banks, a decline in borrowings could have a major bearing on their earnings. The banks, which are already under the huge burden of NPAs, might also see a surge in bad loans as borrowers are more likely to default if interest rates move up.
The rate hike will increase the cost of doing business for companies, as they would have to pay a higher interest on their loans.
"The cost of doing business goes up because of the hike and it will impact capex (capital expenditure) by the industry," Confederation of Indian Industry (CII) president and vice-chairman of Bharti Enterprises, Rakesh Bharti Mittal recently told reporters.