Repo rate is the rate at which RBI lends money to commercial banks when they run out of funds. The commercial banks have to provide RBI recognized securities that are above the Statutory Liquidity Ratio (SLR) to get these short term loans from the RBI. The rate of interest that the RBI charge from the banks is called repo rate. Introduced by RBI on the recommendations of the Narasimham Committee, the repo rate is one of the main tools used by the RBI to keep inflation under control.
Importance of Repo Rate
The Reserve Bank of India uses different monetary instruments to control the credit system of India. Repo rate is considered one of the most important tools among them. It is an effective monetary instrument that helps to control inflation. When inflation hits the nation, the repo rate is increased by the RBI as it lowers the inflow of cash in the economy. On the other hand, when a cash crunch is created in the economy, RBI lowers the repo rate so that the flow of liquidity is maintained.
Impact of Repo Rate Cut on Investments
Owing to the slow economic growth, RBI has recently lowered the repo rate from 5.40% to 5.15%. The decrease in the repo rate by 25 basis points will, directly and indirectly, affect your investments too. Some of the ways in which this rate cut will affect investments are:
Mutual Fund Investments
Changes in the repo rate affect stock prices, which, in turn, affects the index prices. The lowering of the repo rate makes it easier for investors to take a loan, and this leads to higher stock prices. As the stock price increases, the chances to have a higher return in the mutual funds also increases.
Lowering of the repo rate also helps to increase the demand in the market as funds become available at affordable rates of interest. This increase in demand leads to higher consumption, which in turn leads to an increase in the volume of manufacture. This cycle ensures that the market runs smoothly. After the rate cut, if this cycle maintains, then the individual savings in mutual funds can expect higher returns in the long run.
When the repo rate is lowered, it is generally expected that the commercial banks will reduce their fixed deposit rates. The lowering of the rates will result in a lower return at the time of maturity. However, the lowering of the rates of the fixed and term deposits will not be in proportion to the decrease in the repo rate. It is because lowering the interest rate to that extent will discourage the customers to invest in fixed deposits, which will result in a liquidity crunch in the banks.
Some of the nationalized banks of India have brought down the interest rates on large savings accounts after RBI has lowered the repo rate. In some of the banks, the interest rates on savings deposits above Rs. 1lakh might get affected, while the deposits below Rs. 1 lakh will remain unchanged. Likewise, the interest rates charged on various short term loans will also get affected due to the rate cut.
RBI changes the rates of the principal monetary policies according to various macroeconomic factors. And, whenever there is a change in these rates, every arena of the economy is affected. Other than the factors listed above, the cut in the repo Other than the factors listed above, the cut in the repo rate also affects the interest rate on big amounts loans like home loans, car loans, etc. It is because the commercial banks revise their MCLR proportionately, below which they cannot provide loans to the customers. rate also affects the interest rate on big amounts of loans like home loans, car loans, etc. It is because the commercial banks revise their MCLR proportionately, below which they cannot provide loans to the customers.