In a surprising move, RBI on Wednesday (May 4) announced a 40 basis point hike in the repo rateWhereas repo rate is the rate at which RBI lends to commercial banks, a move set to make lending costlier. The news came out suddenly and as the shock hit investor sentiment, the Sensex broke over 900 points between 2 pm and the close of the market. The benchmark index ended sharply lower at 55,669, down 1,306 points, or 2.29 per cent.
What was the major concern driving RBI?
inflation has been a major concern, and persistently high food and fuel prices forced the RBI to call its mid-term meeting monetary policy committee (MPC), where it was unanimously decided to increase the repo rate by 40 basis points to 4.4 per cent.
it was also decided to Increase in cash reserve ratio (CRR) by 50 basis points to 4.50 per cent To eliminate liquidity and bring down the increased inflation.
But what could be the effect of this decision?
as emerged from India COVID-19 After the pandemic, the economy – which is largely consumption-oriented – began to witness a return to demand for housing, white goods, travel, etc. While the decision to hike rates is mostly to curb inflation, there could be a rise in rates and a return to liquidity. It also slows down the pace of growth in the economy, and puts the brakes on the revival process.
If consumption is hit, this in turn could hurt capacity utilization for companies across sectors, and could even stall India Inc’s investment plans.
Should people worry about rate hikes?
A hike of 40 basis points is not a cause for concern as many more rate hikes are likely this year, and the pace at which the RBI is going to do so. It remains to be seen whether the RBI hikes the aggregate by 50-100 basis points this year, or whether the hike is much higher in the range of 150-200 basis points.
In the second scenario – a hike in rates by up to 150-200 basis points – existing home loan customers and even potential home buyers could suffer substantial losses. EMI-based purchases of consumer durables by households may also get hit, hurting consumption in the economy.
To what extent can your EMI be specifically affected?
An increase of 40 basis points coupled with increase in cash reserve ratio means that banks and housing finance companies can immediately raise rates by more than 40 basis points. So, if they raise the rates by 50 basis points from 7 per cent to 7.5 per cent, the EMI on a principal of Rs 50 lakh for 15 years will increase from Rs 44,941 to Rs 46,350. 1,409 in monthly EMI if the tenure is kept constant.
However, if rates increase by 200 basis points by the end of the year, the customer will see his loan rate increase from about 7 percent to 9 percent by that time. In that scenario, his EMI for the same loan would increase to Rs 50,713 – an increase of Rs 5,772 per month. This will be a big dent for the individuals who saw their income fall during the Covid period.
If the borrower cannot, or does not want, to go for an increase in EMI, she will extend her loan tenure from 180 months (15 years) to 191 months and up to 240 months in case of an increase of 50 basis points (20 year) if the rates increase by 200 basis points during the year.
Car and two-wheeler sales have already been hit by rising vehicle costs and declining household income in rural and semi-urban areas. A hike in interest rates will further impact the affordability of the vehicle – as fuel is so expensive now.
What should existing home loan customers do?
Since the post-tax fixed deposit income for an individual in the highest tax bracket currently ranges from 3.1 to 4.1 per cent, existing home loan customers can use some of their fixed deposits to pre-pay a portion of their home loan. will do well for
While rates still remain relatively low, and may go up in the next one or two years, existing home loan customers should look to increase their EMIs so that the impact of subsequent rate hikes in the next 12-18 months is minimized. EMI and tenure of the loan.
What about investment? How does debt grow relative to equity?
As a result of the low interest rate environment, most fixed deposit instruments are earning interest rates between 4.5 per cent to 6 per cent for investors, depending on the tenure; However, as a result of high inflation, real interest earnings have been negative.
For those in the highest tax bracket, investing in fixed deposits makes even less sense as the after-tax returns will be in the range of 3.1 per cent to 4.1 per cent, which is much lower than the 7 per cent inflation rate.
If a fixed deposit or a small savings instrument is earning 6 percent, and inflation is 7 percent, then real interest income on a net basis is negative (nominal interest rate – inflation). Most small savings schemes are now generating negative real rates of interest; Only PPF (7.1%) and Sukanya Samriddhi Yojana (7.6%) have now received interest income higher than the inflation rate.
While equity investments can only beat inflation, investors who still want to stick with pure debt products should not lock in for longer durations, but go for shorter duration products.
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Some investors may also look at corporate deposits offering relatively high interest rates, but they should seek professional advice, and weigh their rating and risk, before going for a specific offering.
However, investors should focus more on equities, as any financial instrument should serve the purpose of growing your money over time. With inflation currently around 7 percent, any income below 7 percent net of taxes, actually makes you lose money.
Financial advisors say that conservative investors will have to bring equities into their portfolios in some form or the other, and be prepared to take some risk and live with some volatility. Investors need to improve their asset allocation and look at mutual fund offerings such as Conservative Debt Hybrids, Balanced Advantage Funds and Equity Savings Schemes (which invest in equity, debt and arbitrage securities). Investors need to understand that higher returns can only come from equities and it also leads to better tax management.
In fact, the fall in the markets due to rising interest rates should be taken as an opportunity to invest for the long term.