In a surprise move, the Reserve Bank of India releasing its third quarter monetary policy increased the short term lending rate or repo rate to 8 per cent from the existing 7.75 per cent. The move came as a surprise to most financial experts as it was announced despite the lower inflation rates released in December. While RBI justified the revision saying it is an essential bitter pill to swallow to bring down retail inflation, business leaders mentioned this move as disappointing.

Let us take a look at how RBI’s repo rate policy impacts loans, fixed deposits and other areas of life for the common man.

Understanding Repo Rate:

Before getting into the reasons why the increase in repo rates may be bad news for the common man with increased loan EMIs, it is essential to understand what repo rates are and how they impact the banking system. In a layman’s term, Repo rate is the rate at which the Reserve Bank of India lends money to commercial banks. The increase in repo rates for 7.75% to 8% would mean that the RBI would charge a higher rate of interest for all money given out to various commercial banks. The bank in turn would be forced to charge its customers a higher rate of interest when it comes to home and auto loans to offset the higher interest rate.

Immediate Term Impact on Deposit and Lending Rates:

Most financial experts are of the opinion that the immediate impact of the increase in repo rates may not necessarily get translated into higher deposit and interest rates offered by the banks. The banks already fighting a weak loan growth rate due to a sluggish real estate sector are unlikely to pass on the increased rates to the customers immediately. Depending on the liquidity condition of the banks, the changed interest and deposit rates may be passed on once banks analyze their cost of funds over the next few days.

Brace Yourself for Higher EMIs:

Once the banks analyze their cost of funds and their overall liquidity condition, the higher interest rates would have to be passed on to the end user or the retail customer. This would effectively mean higher EMIIs on home loans, auto loans as well as personal loans.

The home loan segment is likely to face the brunt of this increase in repo rate. Financial experts believe that since the car loan market is dominated by various schemes, financers are likely to absorb the rate hike by increasing discount offers. Majority of car loans are on fixed rate basis compared to home loans with majority offered on floating rate basis. Any rate impact due to the repo rate increase would not necessarily impact the auto loan market as much as it would impact the home loan segment. Real estate companies and developers already facing the brunt of sluggish sales are disappointed with this rate hike as it is likely to dampen interest in the real estate segment.

Repo Rate and Home Loans:

The question as to whether banks would actually increase the lending rates amid the hike in the repo rates remains an open one. Once done with analyzing their costs of funds and bank liquidity conditions, the banks would have no option but to increase their interest rates in the coming months.

For example, assuming the interest rate on a 20 year housing loan of Rs 75 Lakh is increased from 11 to 11.25 %, it will translate into an increase of approximately Rs 1279 per month in the EMI.

Repo Rate and Fixed Deposits:

The short term impact of such a hike is does not augur well for investors parking their money in fixed deposits. Being an election year, the banks may reduce retail deposit rates only slightly for below one-year fixed deposits simply to keep their margins intact. The long term policy of the RBI is now aimed at fighting retail inflation. Once the inflation rates are substantially lowered, the prospect of investing in fixed deposit over the long term offers lucrative gains. The immediate impact on small fixed deposits may be a damper but banks are unlikely to lower interest rates across the board as of now giving relief to a vast section of fixed deposit account holders.