Impacts of rise in repo-rate and reverse repo-rate-mymoneykarma

Framing the monetary policy is one of the primary functions of Central Bank. Over the last decade, Monetary Policy Committees globally have changed their approach towards formulating the monetary policy. During this period, one of the significant changes incorporated in the policy framing technique of the RBI is the change in instruments used to achieve inflation targets and ensure financial stability in the economy. Post-2002, with the introduction of LAF(Liquidity Adjustment Facility), RBI has been using repo-rate and reverse repo-rate as the instruments to achieve the medium and long-term goals of monetary policy. Repo-rate refers to the rate at which RBI lends money to the commercial banks and reverse-repo rate is the rate at which the commercial banks lend money to RBI.

Trends in repo and reverse-repo rate have been reasonably stable over the last 4-5 years. However, in the second bi-monthly review of monetary policy on Wednesday, RBI changed its status quo stance on these policy rates. The ruling repo-rate was increased by 25 basis points, i.e., from 6% to 6.25% and the reverse-repo rate has reached a 6% benchmark. The reason cited by the RBI regarding the upward revision of repo-rate is the rise in inflation expectations in the first half (H1) of 2018 which had endangered the financial stability of the economy. World Bank report suggests that crude oil prices will rise to 20% this year, which could further deepen India’s Current Account Deficit. The 25-basis-points rise in the repo-rate, in such a scenario would result in a decline in net borrowing, ultimately de-motivating new borrowers from applying for loans or credit. Compare and discover the best credit card for you with additional perks and better rewards at mymoneykarma.

A decline in the net borrowings would lead to lower levels of liquidity in the economy. An outrageously high repo-rate could depress the funds available in the banks, so, the interest rate on deposits is also increased by the commercial banks, to attract more depositors.

Impacts of rise in repo-rate

Increased cost of loans- In situations of financial crunch, the commercial banks approach the Central Bank of India to finance their expenses. A rise in repo-rate would generate pressure on the banks since borrowing from the RBI becomes costly. To solve this issue, banks tend to increase the rate of interest on housing, auto and personal loans thus increasing the EMIs.When the interest rate on loans rises, people shy away from borrowing money from the commercial banks.

When the interest rates are rising rapidly, home loans get costly and people refrain from buying a house. Fluctuations in policy rates should not deter anyone from buying their dream home, let mymoneykarma guide you to choose the best home loan scheme which would rescue you from undesirable fluctuations in the lending market.

Increase in the interest rate on deposits- Liquidity refers to the ease at which a financial asset can be converted into currency. A higher repo-rate would increase the interest rate which in turn affects the liquidity of the economy negatively. So, in order to father more funds, banks tend to attract depositors by raising the rate of interest on time and fixed deposits.

Who are the gainers?
The current policy stance of RBI could be a blessing for the depositors and investors since a relatively lesser quantum of deposit/investment could incur larger capital gains due to the higher interest rate applicable on such deposits/investments. Trading in rate sensitive sectors like real estate, banks and automobile has increased by more than 1% with the rise in repo-rate. So, if someone has invested in stocks, shares or bonds they’ll be gaining from the upward shift in policy rates. RBI has also revised the upward limit for priority sector lending from 25 lakhs to 35 lakhs, so now more people can enjoy the benefits of priority sector lending in case of home loans.

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To sum up, the gainers are-
Investors in real estate
Investors in automobile sector
Investors in banking sector
Customers applying for home loans worth less than 35 lakhs
Fixed Deposit and Recurring Deposit investors

Who are the losers?
New borrowers and the commercial banks that are already constrained by lack of funds will tend to lose from the recent changes in monetary policy. Anticipating RBI’s stance on repo-rate, SBI and Axis Bank have already increased the rate of interest on home loan by 10 basis points. A 25 bps increase would have a negative impact on the bond yields since bond prices are inversely linked with repo-rates. So, a hike in repo-rates would decrease the expected bond prices, making bond shares less attractive.
New and existing borrowers
Investors in bond shares

The six-membered Monetary Policy Committee of RBI, headed by the RBI Governor, Urjit Patel, has unanimously made an upward revision in the reverse-repo rate as well. Since reverse repo-rate is the rate at which the commercial banks lend to RBI, when RBI increases the reverse repo-rate, it is aiming at credit contraction in the market.

Impact of rise in reverse-repo rate
Decline in money supply in the economy- The increase in repo-rate to 6% would result in a decline in money supply in the economy since the commercial banks would prefer supplying money with RBI due to the higher rate of interest applicable on such deposits which in turn increases the earnings of the banks.
Decline in supply of credit- Rise in repo-rate is aimed at contracting the credit available in the financial system. When the reverse repo-rate increases, the rate of interest on credit sources rises as well, hence, leaving the creditors cold when it comes to applying for credits from the banks
Decline in rate of inflation- Inflation refers to the increase in the prices of commodities. The inflation expectations of the economy for FY 2018-19 have increased substantially. The rise in reverse repo-rate would discourage credit supply in the economy since people will stop taking loans from the banks at higher interest rate. Lesser credit supply in the market would ultimately reduce demand for commodities, hence, lowering their prices.

The inflationary undercurrent running in the global financial market has directed the policymakers of many emerging economies to assume a neutral stance on essential policy rates. The ever-rising prices of crude oil and increase in the Consumer Price Index(CPI) based inflation have emerged as the prominent reasons for raising the repo and reverse-repo rate even in developed economies. A purely economic analysis of the current policy stance of the Reserve Bank of India would suggest that with each fiscal year, more money would be sucked from the currency pool, thus reducing the inflationary pressures on the economy.

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This release was published on openPR.