Explained: Here’s How RBI’s 50 bps Repo Rate Rise Affects You

In its bi-monthly review on Wednesday, the Reserve Bank of India raised the repo rate by another 50 basis points. This decision and the RBI’s emphasis on withdrawing its accommodative policy, both in response to rising inflation, are expected to drive interest rates higher in the banking system.

Why did RBI increase the repo rate?

The 50 basis point increase, which follows a 40 base point hike on May 4, was made with a view to controlling inflation. Noting that headline inflation increased by 170 basis points between February and April 2022, the RBI projected it at 7.5% in the first quarter of FY22, 7.4% in the second quarter, 6.2 % in the third quarter and 5.8% in the fourth quarter, with core inflation of 6.7% for 2022-23. The RBI aims to bring inflation back to its target of 4% (±2%). The two repo rate hikes in the past five weeks, totaling 90 basis points, bring the rate to 4.9%.

The repo rate refers to the rate at which the RBI lends to commercial banks. When interest rates rise, it makes money more expensive, which leads to reduced demand in the economy and lower inflation.

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Although it appears to be supporting the economic recovery from the impact of the pandemic, RBI’s concerns over inflation have been the main driver of the rate hike. He said in his statement on Wednesday: “War in Europe persists and we face new challenges every day that compound existing supply chain disruptions. As a result, food, energy and commodity prices remain high… Much of the rise in inflation is mainly attributed to a series of war-related supply shocks. In these circumstances, we have begun a gradual and orderly withdrawal of the extraordinary accommodations instituted during the pandemic. »

What will be its impact on borrowers and depositors?

While borrowers and depositors should see higher lending rates and offers on deposit rates, respectively, over the coming days and weeks, borrowers should be hit earlier. Banks and housing finance companies, which have already raised lending rates between 40 basis points and 50 basis points after May’s 40 basis point repo rate hike, are now expected to raise rates again .

If the 90 basis point hike in the repo rate increases the lending rate by 100 basis points, it will have a significant impact on EMIs. For example, if your home loan rate increases by 100 basis points from 7% in April to 8% in the next two weeks, the EMI on principal outstanding of Rs 50 lakh for 15 years will increase to Rs 44 941 to Rs 47,782 – a jump of Rs 2,841 per month if you keep the mandate unchanged.

If rates were to rise by 150 basis points by the end of the year (which is expected given RBI’s heightened inflation concerns), the lending rate would increase to 9.5% and the EMI for the same loan at Rs 49,236 – an increase of Rs 4,295 per month. This would severely hit people whose incomes have already fallen from pre-Covid levels.

So, are more rate hikes expected?

Given the RBI’s projected inflation of 6.7% for 2022-23 and heightened concerns over it, market participants believe it could opt for a further 50-100 basis point hike on the rest of the year. Indeed, RBI Governor Shaktikanta Das said that the future rate hike decision would be in line with inflation developments. “These are extremely uncertain conditions and it is not possible to provide any guidance on guidance…we will deal with it as the situation unfolds,” Das told media on Wednesday.

In a report released after the RBI’s rate hike, Bank of Baroda said: “RBI’s hawkish policy is largely focused on heightened inflationary concerns. It raised the policy rate by 50 basis points. The CPI forecast has been revised upwards by 100 basis points in FY23 to 6.7% (our estimate: 6.5%). More importantly, over the next three quarters, headline CPI is expected to trade above RBI’s upper tolerance range…We expect another 50-75bn ps rate hike in the current cycle .

A report by HSBC Global Research estimated that RBI could raise repo rates by 60 basis points to 5.5% by December 2022 and by 110 basis points to 6% by mid-2023.

What is the RBI’s assessment on inflation?

Inflation is expected to be above 7% – well above the RBI’s comfort level of 4% (±2%) – in the first two quarters of the current financial year. RBI forecast inflation of 7.5% in the June quarter and 7.4% in the September quarter. International crude oil prices remain elevated, with risks of further spillovers to domestic pump prices. Electricity price revisions also carry upside risks. Edible oil prices remain under pressure from unfavorable global supply conditions, despite a recent correction due to the lifting of an export ban by a major supplier. Early results from companies in the manufacturing, services and infrastructure sectors surveyed in RBI’s surveys suggest that they expect further pressures on input and output prices.

The RBI expects inflation of 6.2% in the December quarter and 5.8% in March 2023. The high level for calendar years 2022 is expected to force the RBI to raise rates further and withdraw system liquidity.

What will be the impact of the withdrawal of the accommodative policy?

Interestingly, the RBI removed the word “accommodating” from the policy position. The RBI Policy Panel, chaired by the RBI Governor, decided to remain focused on withdrawing accommodation to ensure inflation remains within target. The RBI had injected huge liquidity into the system in 2020 to counter the impact of the pandemic. Although this has supported the economic recovery, it has also been the main reason for the rise in inflation.

RBI market operations had led to lower liquidity in May. Yet overall liquidity in the system remains largely in excess, with average daily absorption under the Liquidity Adjustment Facility (LAF) moderating to Rs 5.5 lakh crore from May 4-31, from Rs 7.4 lakh crore from April 8 to May 3, in line with the housing phase-out policy. The pullback will also put upward pressure on interest rates.

Will consumer spending be impacted?

The withdrawal from politics and the rise in rates are expected to impact consumption and demand in the economy. The impact is likely to be most pronounced in non-discretionary consumer spending. “Recently released GDP data showed year-on-year growth in private consumer spending, indicating that economic activity remains sluggish,” said Indranil Pan, chief economist, Yes Bank.

The forecast of a normal monsoon is expected to boost kharif plantings and crop production, according to the RBI’s policy panel. This will support rural consumption. The rebound in contact-intensive services should support urban consumption. RBI surveys suggest further improvement in consumer confidence and household optimism for the one-year outlook.

“The RBI’s optimism on growth is important as the performance of the economy in the first two months has been quite impressive. Rising interest rates will help ensure that growth is not affected as inflation unchecked can affect consumer discretionary, which in turn will affect growth,” said Madan Sabnavis, Chief Economist, Bank of Baroda.

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