RBI's steep rate cut: How it affects you

On Tuesday, Reserve Bank of India announced a 50 basis point cut in the repo rate. While borrowers have a reason to cheer, for consumers it's a tricky situation.

FP Editors December 20, 2014 09:44:14 IST
RBI's steep rate cut: How it affects you

On Tuesday, Reserve Bank of India (RBI) governor D Subbarao stunned everyone by announcing a 50 basis point cut in the repo rate, its main policy rate. (100 basis points = 1 percentage point.) Economists had only expected a 25 basis point cut given the relentless pressures on inflation.

So how does the first repo rate cut in three years affect you?

As a home loan borrower: No doubt about it, home loan borrowers have good reason to celebrate. Apart from expecting lower interest rates of at least 25 basis points in the next few weeks/months, the RBI has also ordered banks to ditch the pre-payment penalty clause (which kicks in if you pay your home loan before it is due or opt to refinance it with lower-cost loans) on home loans taken on a floating rate basis.

RBIs steep rate cut How it affects you

No doubt about it, home loan borrowers have good reason to celebrate. Reuters

In addition, the RBI also ordered banks to ensure that they offer more home loans with fixed rates. Currently, most home loans are given to borrowers on a floating-rate basis, which leaves borrowers uncertain of how much they have to pay in future because floating rates are aligned with changing market rates. The RBI wants to reduce that uncertainty for borrowers -- and for banks to assume that risk.

Both measures should boost home sales, which have been sluggish for most of 2011-2012 because of soaring borrowing costs and high property prices. However, don't expect real estate developers to lower house prices. According to a Business Standard report, the repo rate cut offers too few savings to contemplate slashing prices. Typical.

As a car loan borrower: Potential car buyers can also heave a sigh of relief. Lower interest rates will slightly lower equated monthly installments (EMIs) of borrowers. About 70 percent of all retail car sales take place with the help of bank loans.

Car sales are estimated to have expanded by a meagre 2 percent in 2011-2012.on the back of high interest costs and soaring petrol costs. For now, at least one factor seems to have eased.

Most media reports suggest that car companies are very hopeful that the rate cut will translate into higher sales.

As a consumer: The situation for consumers is a bit tricky. While loan costs might come down, the deep rate of 50 basis points has the potential to increase demand for a host of commodities. If supply doesn't increase to match that demand, prices will rise.

In other words, higher demand could add to inflationary pressures in the economy, which is already struggling to contain prices at manageable levels. If indeed inflation rises to dangerous levels, the RBI will be forced to go into rate-hiking mode, a possibility that has not been ruled out.So, a rate cut is not so great news for consumers.

As a bank deposit holder: A cut in the repo rate will not automatically lead to a cut in the bank deposit rate, most banks have said citing a host of constraints. The RBI has also ordered banks to reduce the interest rate gap between retail and bulk deposits. It's possible banks might end up lowering rates on bulk deposits to align them with those on retail deposits, although detailed guidelines by the RBI on the matter will only be issued later.

In addition, the RBI announced that every bank customer will be entitled to one savings deposit account without the requirement to maintain a minimum balance. The idea is to include more people under banking services, the central bank said.

As a business: Companies will be able to access funds at slightly cheaper costs now. While the cut in costs may not be significant, a mild reduction is definitely better than none at all. Moreover, if businesses sense that there may not be many more rate cuts in the offing given the threats to inflation, they might start investment activity at least at the margins.

As this Firstpost story notes, the government will also need to tackle policy logjams to get investment activity really fired up. Interest rates alone cannot do the trick.

As a job seeker: The outlook may have got mildly brighter, at least for the medium term. Lower borrowing costs will ease some of the financial burdens of companies, and that should get them to at least start thinking on expanding capacity and hiring more staff.

But don't expect the job market to be flooded with offers. A 50 basis point cut, while unexpectedly large, cannot alone send companies on a hiring spree because the future outlook for several companies still remains uncertain. But corporate sentiment is expected to turn at least mildly positive.

As a stock investor: It's a mixed bag for stock investors. Interest costs for companies might come down, easing pressure on margins and net profits. However, that could be offset by falling demand if inflation spikes to uncomfortable levels.

A lot also depends on how the rupee and foreign investors behave, especially as the troubles of multinational companies like Vodafone rumble on.

A rate cut in theory is good, but for stock investors, the bad days are not yet over.

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