RBI has cut the repo rate and reserve repo rate by 35 basis points (bps). A basis point (BPS) is a common unit of measure for interest rates and one basis point is equal to 0.01% This is the fourth time in a row that the RBI has cut the repo rate starting from February 2019. RBI reduced the key policy rates by 25 bps each time in the three previous monetary policy reviews. Now, the key policy rate has been reduced by 110bps after adding fourth rate cut and currently, the repo rate stands at 5.40 percent down from 5.75 percent.

Repo rate: The rate at which the central bank(RBI) of a country lends money to commercial banks is known as the Repo rate. To control inflation, the Repo rate is used by monetary authorities.

Relationship between Repo rate and Inflation: Repo rate is used to control Inflation. For example: to reduce inflation, RBI increased the repo rate and this will increase the cost of borrowing and lending of the banks. The availability of credit and demand decreases as the rates are high, resulting to a decrease in inflation.

Benefits of repo rate cuts: Rates cut by 35 basis point by Reserve Bank of India is a positive decision. This move will allow banks to lend to priority sectors, including to housing sector of up to Rs 20 lakh loans. Increase the credit flow especially to the affordable housing sector. Boost the demand for investment, no doubt. The takers of home and car loans will get benefited.

Effects of repo rate cuts:

  • Pensioners and senior citizens will be at loss due to a decrease in the interest rate.
  • Reduction in fixed income returns.
  • Recently, the State Bank of India (SBI) reduced interest rates on fixed deposits (FD) in line with the reduction in key rates.
  • For short-term tenures, the interest rate cut has been sharper i.e. up to 179 days by 50-75 bps. The bank cut rates by 20 bps for longer tenures.
  • The government also reduced the interest rates on small savings schemes by 10 bps for the July-September quarter.

Impact of the latest rate cut on both new and existing borrowers. Effects of Repo Rate Cuts on borrowers:

  • A fourth rate cut is good news for borrowers as EMIs (equated monthly installments) are likely to go down.
  • For existing borrowers whose loans linked to MCLR this rate cut will see a reduction in EMI outgo only when bank lowers its MCLR.
  • With loans linked to the base rate or BPLR

If your home loan is still linked to the base rate or BPLR, then one should consider switching to an MCLR-linked loan. This is because MCLR offers better transparency of policy rates.

  • For new borrowers

As a new borrower, one has the option to choose to take your home loan linked with either the MCLR or repo rate.

What one needs to do?

  • If one is planning to park his/her money in fixed income instruments such as debt funds, then short-term and ultra-short-term funds would be a better option. For investors, the advice is to stick to shorter-term bonds.
  • For depositor, one may lock in at the current levels.
  • A new borrower should opt for floating-rate loans.
  • If one is investing in a debt fund, one can continue looking at ultra-short-term and short term funds.

Way forward:

  • Small tinkering of the repo rate should not make much of a big difference and the bigger picture should be kept in mind.
  • The cut is a good one if it is passed on by the banks and bank rates come down.
  • The RBI will now need to step in for accelerating the transmission of the rate cut, for the consumers to feel the benefit of lower rates.