The Reserve Bank of India has slashed its repo rate by 25 basis points for the third time in a row. The repo rate, which now stands at 5.75 per cent, is the rate at which Reserve Bank of India lends to the banks. With subdued inflation and weak economic growth, the move to lower the key rate was on expected lines. For the first time since September 2010, the repo rate is below the 6.00 mark.
The central bank has also been prodding banks to transmit more of the policy rate cuts to consumers. However, only a small portion of the repo rate cuts have been passed on to the consumers. With deposit rates falling sharply, it is to be seen if the banks will pass on the lower rates on credit products to its borrowers.
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Here is what the RBI cutting the repo rate would mean for your money:
The rate cut would benefit the existing customers only if the commercial banks follow the RBI’s move with a reduction in Marginal Cost of Funds based Lending Rate (MCLR) as well, and only if the loan reset date is nearing. The equated monthly instalments (EMIs) are calculated on the basis of the current interest rates. So, if your bank cuts interest rate and your loan reset date is nearing, your EMI figure could also come down. For example, if you have taken a Rs. 50 lakh loan at an interest rate of 8.7% for 20 years, your EMI is Rs. 44,026. But if the loan interest rate were to be reduced by 10 basis points, your new EMI for the same loan would be Rs. 43,708, i.e. Rs. 318 cheaper. A new home loan borrower can take a home loan now linked with the MCLR. Many banks had announced a reduction in lending rates after the RBI rate cut in April this year.
A reduction in repo rate means lowering of bank deposit rates, and a fall in fixed deposit returns. Banks may go for a competent interest rate hike on fixed deposits to retain their existing customers. At present, the best interest rates being offered by banks on FDs are in the 7.50 to 8.25% range. You may consider laddering your fixed deposits, which simply means spreading your FD investments across timelines, depending on your financial goals. Despite the lower interest rate, FDs can be a good option for investors with lower risk appetite.
Debt mutual funds have taken a battering lately owing to defaults by various entities. Defaults followed by ratings downgrades have negatively affected several mutual funds holding its bonds. We’ve not seen the end of the crisis with debt funds yet. Debt funds offer benefits such as indexation of Long Term Capital Gains, which means higher-post tax returns for you. However, debt funds aren’t risk-free, as we’ve seen lately. You must evaluate the quality of investments in your debt fund portfolio and decide if you should stay invested or exit. If your objectives are short-term, you can strongly consider cashing out to avoid further volatility.
(The writer is CEO, BankBazaar.com)