RBI increases repo rate by 0.5%: How does this impact you?

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RBI Monetary Policy

The Reserve Bank of India (RBI) announced a rise in the policy rate on Friday morning with immediate effect. As per the RBI governor, the Indian economy is showing signs of broadening. There were other important updates post the RBI's three-day Monetary Policy Committee (MPC) meeting. Let us look at the details of the meeting outcome.

RBI Monetary Policy update: Repo and other rate increase 

Repo rate refers to the rate at which commercial banks borrow money by selling their securities to the Central bank - the Reserve Bank of India (RBI) to maintain liquidity, in case of a shortage of funds or due to some statutory measures. 

The MPC decided to raise the rates on the back of inflationary pressures and higher supply shocks. The RBI has hiked the policy repo rate by 50 basis points to 5.4%. In June, RBI increased the repo rate by the same amount. In a span of 4 months, the repo rate has been increased by 130 basis points. Repo rate is now back to pre-pandemic level and highest since August 2019. RBI Policy stance is retained at Withdrawal of Accommodation.

The rate increase will directly impact the fixed deposit investors as banks will eventaully increase fixed deposit rates for depositors. It has also decided to raise MSF (Marginal Standing Facility) and Bank Rate to 5.65% from 5.15%. Standing Deposit Facility (SDF) rates have been revised from 4.65% to 5.15%.

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RBI Monetary Policy: Real GDP forecast

The Reserve Bank of India (RBI) has retained the GDP forecast for FY23 at 7.2%. The governor added that the domestic economic activity is showing signs of broadening with high-frequency indicators suggesting improvement in urban demand. While rural demand shows a mixed trend. The quarter-wise growth projection stood at:

  • Jul-Sep 22 at 7.1%
  • Oct-Dec 22 at 6.4%
  • Jan-Mar 23 at 5.8%
  • Apr-Jun 23 at 5%

RBI Monetary Policy August 2022 Update: Inflation projection

RBI has left the inflation forecast for the country unchanged at 6.7%. It now sees inflation for Q2 at 7.1%, Q3 at 6.4%, and Q4 at 5.8%.

The central bank said that inflation in India is expected to remain above the central bank's 6% threshold levels in the second and third quarters of the current fiscal year. MPC has stressed that sustained high inflation could destabilize inflation expectations and harm growth in the medium term.

Global financial markets are volatile and that is impacting domestic financial markets leading to imported inflation. 

RBI MPC in August: NRIs can now pay home bills

RBI will start a new initiative where it has proposed to enable Bharat Bill Payment System that can accept cross-border inward bill payments. It will allow NRIs to undertake bill payments for education, utilities, and other such payments on behalf of their families in India. The move will benefit the senior citizens directly.

RBI Monetary Policy Update: Two-way fine-tuning liquidity operations

RBI will conduct two-way fine-tuning liquidity operations depending on evolving financial conditions. Going forward, the RBI will remain vigilant on the liquidity front and conduct two-way fine-tuning operations as and when warranted.

RBI MPC: Other important updates

  • RBI proposed to enable standalone primary dealers to offer all forex market-making facilities. They can offer all forex market-making facilities as permitted for Category-1 authorized dealers.
  • Bank credit growth has accelerated to 14% as against 5.5% a year ago.
  • On the falling rupee, Das said, depreciation of the rupee is due to the strength of the dollar, rather than any weakness in India's macro fundamentals. The central bank will remain focused on maintaining the stability of the rupee.
  • FDI inflows improved to $13.6 billion in Q1FY23, against $11.6 billion in the corresponding period last year

RBI Monetary Policy: Positives post Repo Rate increase

The increase was in line with estimates from most analysts. Below are the positives post the repo rate increase:

  • The rupee appreciates 37 paise to 79.10 against the dollar after the MPC hike.
  • The NIFTY50 index rose 0.45% (Friday noon), and the Sensex advanced 0.51% after the policy decision, as the repo rate hike was largely in-line with market expectations.
  • Shares of banks and auto companies either maintained their gains or climbed further after the RBI's hikes repo rate.

What does the RBI’s repo rate increase mean for you?

Impact on debt mutual funds

When yield rises, bond prices fall, which reduces the profitability from debt investments. This forces debt investors to pull their money out of the market and wait until the bond price rises so that they can earn more. Hence, debt funds may face short to medium term volatility.

  • Due to their higher sensitivity to yield changes, longer duration funds will see a higher impact of yield changes.

What should you do now?

  • Stick to high-quality AAA-rated low-duration funds and bonds. Prefer safety over high yields in this volatile market. 
  • There is a significant tax advantage in holding a debt fund for more than 3 years. For a more than 3-year investment horizon, an investor should prefer short duration (duration < 3) fixed income instruments over a long duration. 
  • The interest rates are expected to move higher over the next 3-6 months. Shorter duration funds are likely to outperform in this scenario, given their lower sensitivity to interest rate changes as compared to long-duration funds.

Effect on Loans and Other Credit Instruments

  • The increase in repo rate will directly affect the banks lending rates.  In order to compensate for the higher repo rate, the banks are likely to increase the interest rate they charge from borrowers. Hence, home loans, personal loans and other credit facilities are going to get costlier. This will majorly affect home loan borrowers who have opted for floating interest rates. 

How Will Deposit Rates Change?

  • Increase in repo rate is not seen as something desirable by investors. However, one positive thing that usually happens when repo rate rises is an increase in interest rates offered in bank deposits. However, the transmission of interest rate hike may take a bit longer. Eventually, it is expected that the banks will increase interest rates on deposits as well.