RBI hikes repo rate by 40 bps | EMIs set to get expensive, FD rates to edge higher, say bankers

Interest rates on home, auto loans and loans to small businesses may soon go up, as early as in the next few months, as banks may pass on the impact of the repo rate hike to end borrowers, bankers and analysts said.

The Reserve Bank of India (RBI), in a surprise move, hiked the repo rate by 40 basis points to 4.40 percent on May 4, citing inflationary concerns. The last time the RBI reduced the repo rate was in May 2020 and has been kept unchanged since then. Also, the RBI hiked the Cash Reserve Ratio (CRR) by 50 basis points to 4.5 percent. The repo rate is the rate at which the central bank lends short-term funds to banks.

The RBI controls inflation in the economy by manoeuvring with interest rates. Usually, inflation increases when there is more demand in the economy than the supply, leading to an increase in prices. Therefore, to control the demand, the RBI will increase the repo rate, thereby making it costly for the banks to borrow from them. Banks, on the other hand, have an option of whether or not to pass the rate hike to borrowers.

In a rising interest rate scenario, it appears that borrowers will have to brace for paying higher equated monthly instalments on their loans and that could impact their purchasing power, bankers and analysts said. This is largely because interest rates on loans are likely to start rising soon. All retail loans, including home loans, car loans or personal loans, are likely to become expensive.

“By raising rates aggressively, the RBI has clearly indicated that the policy stance is hawkish and this will feed into the entire complex of interest rates from fixed deposits to deposit rates,” said Varun Khandelwal, director and fund manager at Bullero Capital.

Analysts said that the impact will be more on existing borrowers, since most of the home loans are at floating rate. These are loans in which the impact of a rate hike is directly passed on to the borrower. According to the RBI’s mandate, all floating rate home loans taken after October 1, 2019, are linked to an external benchmark, which consequently will mean that existing borrowers should be ready to shell out more from their pockets on a monthly basis.

In such a scenario, lenders generally increase the tenure of the loan rather than increasing the EMI amount. This is not economical for the borrower in the long run.

“Given that a large section of the loan has now been linked with the external benchmark, that transmission will be fast for existing borrowers," said Soumyajit Niyogi, Director, Core Analytical Group, India Ratings & Research.

New borrowers should ideally look to get their loans disbursed quickly before banks begin to raise interest, analysts said. This will go a long way in keeping the rate for the entire tenure of the loan low, even when the overall interest rate goes up.

With a rise in interest rates, it also means that fixed deposit rates are set to rise. A fixed deposit (FD) is a financial instrument provided by lenders that gives investors a higher rate of interest than a regular savings account, until the given maturity date. Simply put, banks will now have to pass on the benefit of higher interest rates to depositors who park funds with them.

According to banking analysts, FD rate will be re-priced following the RBI’s repo rate hike. “Depositors should consider locking funds in shorter-duration FDs to benefit from higher interest rates in the coming months,” said a banker at a private bank.

A direct impact of the repo rate hike is felt on the bond market, or the cost of borrowing funds both for the government and corporates. Following the repo rate hike, the 10-year benchmark bond yield climbed to 7.38 percent, its highest in three years. According to money market experts, the unscheduled policy meeting and the magnitude of the rate hike is an indication that the central bank could opt for aggressive rate hikes in the coming months to tame inflation.

“The sudden announcement is a surprise to the market even though we expected 50 bps repo hike in the forthcoming monetary policy. Now it is to be seen whether the RBI will further hike in the coming policy,” Venkatakrishnan Srinivasan, founder and managing partner at Rockfort Fincap, a Mumbai-based debt advisory firm.

“With the sudden hawkish tilt, the cost of borrowing for corporate bond issuers will increase now drastically,” Srinivasan said.

Analysts said that the RBI will have to soothe bond market nerves by indulging in open market operations to soothe market sentiment and prevent the bond yield curve from steepening further. “Unless that happens, an imminent rise to 8 percent on the 10-year g-sec yield is in the offing,” said a treasury head of a state-run bank, requesting anonymity.