Hike in repo rate and its effect on investments


The Monetary Policy Committee (MPC), governed by the Reserve Bank of India (RBI) had first reduced the repo rate to 4% in May 2020 and kept the same unchanged until today. They maintained the status quo on the repo rate for several months, until 4th May 2022 they revised it to 4.40% due to inflationary concerns. The hike in the repo rate by 40 basis points was done to manoeuvre the increasing inflation and discourage banks from borrowing from them.

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The Reserve Bank of India (RBI) controls inflation in the country by managing the repo rate. Inflation is driven by the supply and demand chain in the economy. Higher inflation indicates a higher demand compared to the supply, leading to an increase in prices. To control that demand the RBI then increases the repo rate making it more expensive for banks to borrow from the RBI. This then percolates down to the banks that change the loan and FD interest rates accordingly, affecting the buyers and lenders of the country.
The low repo rate during the pandemic was aimed at stimulating growth and aiding the then-current economic scenario. While the low repo rate allowed for an easy flow of liquidity in the economy, it forced investors who prefer fixed-income instruments to make a strategic decision given the lower interest rates. However, with the surprising and sudden hike in repo rate by 40 bps and Cash Reserve Ratio (CRR) by 50 basis points to 4.5%, the interest rates on fixed income instruments are likely to rise. Hence, choosing the right fixed-income instrument becomes crucial. Financial instruments like fixed deposits will likely offer even higher returns.
Financial experts have been speculating that EMIs are likely to get costlier affecting the purchasing power of the masses, whereas, lenders are set to benefit from the hike. Let’s have a look at the effect this hike will have on our financial decisions. Read on to know more.

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1. Borrowers likely to pay higher EMIs
Interest rates on loans might start rising, which will eventually affect the purchasing power of individuals as they will have to pay higher monthly installments for their buys. Experts are speculating that all loans including personal loans, home loans, and car loans are set to become more expensive. This change will not only affect the new borrowers but also the existing ones since most loans are floating-rate loans. This will end up costing the buyer more than they had anticipated.
2. Fixed Deposit investors may benefit from higher interest rates
For those who are looking to park their surplus money in financial tools, now may be the right time to do so. With the hike in the repo rate, banks and non-banking financial companies (NBFCs) that offer fixed deposit facilities are likely to hike their interest rates as well. Investors can lock in their funds with shorter tenures as they can take advantage of the higher interest rates in the coming months.
In this unscheduled press briefing, the RBI governor Shaktikanta Das announced a unanimously voted hike in repo rates for the first time since 1st August 2018. The next Monetary Policy Committee (MPC) meeting is scheduled between the 6th and 8th of June which will shed more light on how the RBI plans to regulate inflation.