Closely on the heels of its June 2018 rate hike, the Reserve Bank of India has once again increased rates. It hiked the Repo rate from 6.25% to 6.5% and the Reverse Repo Rate from 6% to 6.25%. In June, the central bank had raised both rates by the same magnitude. The current rate hike is part of an ongoing cycle of increasing rates with similar moves emanating from the US Federal Reserve. The RBI Governor noted rising inflation for the third consecutive month in June as one of the factors behind the decision.
The Repo rate is the rate at which the RBI lends to other banks in India. The Reverse Repo rate is the rate at which the RBI borrows from other banks in India. RBI rate hikes also cause other banks to increase rates because they raise borrowing costs for banks. The country’s largest public sector bank, SBI recently increased its own fixed deposit rate for the fourth time in 2018. It had already increased lending rates at the start of June 2018.
An increase in interest rates means the following for you:
- Higher EMIs: Your EMIs for home and other loans are linked to the bank’s Marginal Cost of Lending (MCLR) which is in turn affected by the RBI’s Repo and Reverse Repo rate.
- Deposit Rates: If you are going to invest in Bank FDs, you will get higher rates. However, if you are already locked into an FD at a lower rate, you have lost out. Breaking the FD will carry a penalty (usually the interest rate minus one per cent).
- Debt Fund Returns: Debt Funds hold bonds and bond prices fall when rates are hiked. Hence your debt fund returns will take a knock.
The Banks themselves have sought to reassure borrowers and lenders about more rate hikes in the future. Reacting to the rate hike, Rajnish Kumar, Chairman of SBI said in a tweet that the RBI decision is a clear desire to “frontload the rate hike cycle”. MD and CEO of Yes Bank Rana Kapoor went a step further said that he “expected a pause in the remainder of FY 19”.
If the assessment of these bank chiefs is correct, this would be a good time to buy long-dated bond funds. However, there is little in the inflation data or international environment to indicate that the cycle is coming to an end.