Rbi Hikes Repo Rate - How Will It impact You
In the last meeting of the Monetary Policy Committee (MPC) on 30th September 2022, the RBI had hiked the repo rates by 50 bps for the third time in succession. Since May 2022, the RBI has increased repo rates by 190 basis points (1/100th of a percentage point) from 4.00% to 5.90%. The rates are now 65 basis points above the pre-COVID rate as the RBI has tried to hike the rates in sync with the US Fed.
That leaves us with 3 fundamental questions. What does it mean when we say that the RBI hikes repo rates? What exactly is the repo rate and how is it relevant to investors? Secondly, if the RBI hikes repo rate, how will it impact you? Obviously, there is a direct or perhaps indirect impact that the repo rate will have on individuals, companies, MSMEs and households. Finally, what is the impact of hike in repo rate? How does the repo rate get impacted by RBI rate hikes and what are the downstream effects of such rate hikes.
Let us first understand what is meant by the concept of repo rates and you must have also heard the concept of reverse repo rates. What happens when RBI hikes repo rates? The repo rate represents the rate at which RBI lends money to commercial banks and other scheduled banks in the Indian economy. This is considered to be the most base rate and all other rates in the economy are a spread over this bank rate. If RBI lends to the commercial bank at 5.9% (as is the repo rate now), then the commercial bank will lend to its customers, at least, 2% or 3% higher than that rate to make a margin on lending.
However, there are several important rates that are connected to the repo rate. The first is the reverse repo rate (now SDF), which is currently pegged 25 basis points below the repo rate. That means, if the repo rate is 5.90% then the reverse repo rate is 5.65%. But, what is reverse repo rate. It is the rate at which the RBI accepts deposits from the commercial banks. The reverse repo rate will always be lower than repo rate. Then, 25 basis points above the repo rate is the MSF (marginal standing facility) rate and the bank rate. That means; at 5.90% repo rate, the MSF and bank rate would be 6.15%.
The Bank rate is the base rate used by the banks to lend to customers. The most blue chip customers of the bank will get loans at a small spread over bank rate while the riskier customers will get loans at much bigger spreads over the bank rate. The repo rate is the rate that is announced in every MPC meet, that takes place 6 times in a year. The reverse repo rate and the bank rate are just linked rates. Now, the RBI does not use the reverse repo rate any longer. It has shifted to Standing Deposit Facility (SDF) since April 2022.
RBI Repo Rate movement History
RBI moves the repo rate based on how it wants to move interest rates and liquidity in the market. For instance, if RBI wants to control inflation, it will raise the repo rates so as to tighten liquidity and control inflation. On the other hand, the RBI will reduce repo rates when it has to boost GDP growth in the Indian economy. RBI cut rates aggressively after the global financial crisis in 2008, then again it started cutting rates in 2015 and post COVID, the RBI has once again cut rates. Here is quick repo rate history of the RBI since 2008.
a) Repo rates had peaked at 9.00% in July 2008. When the Lehman crisis struck in October 2008, there were a series of repo rate cuts. The rate cuts were so sharp that by April 2009, the repo rates had bottomed at 4.75%.
b) Since 2010, the RBI again embarked on a rate hike spree and hiked the rates all the way from 4.75% to 8.00% in January 2014. Starting January 2015, the RBI cut repo rates from 8%, all the way to 6.00% in February 2018.
c) In 2018, there was a brief spike in repo rates by 50 bps to contain inflation. However, with growth pangs in 2019, the RBI once again embarked on rate cuts. It started cutting rates in February 2019 from 6.25%, but had to quickly quicken the pace of rate cuts in early 2020 due to the COVID pandemic, taking rates all the way down to 4% by May 2020.
d) The latest round of rate hikes started in May 2022, and since then RBI has already hiked rates by 190 bps from 4.00% to 5.90%, which is where it stands today.
While inflation and growth considerations have been the two biggest drivers of repo rate movements, global action also plays an important part.
Impact of Repo Rate Hike on Various Aspects
Here is how the repo rate hike or cut impact the various aspects of the economy.
- Repo rate hikes makes liquidity tighter in the economy and does a good job of reducing inflation. That has been the logic for the latest run of rate hikes globally.
- A spike in repo rates pushes up the cost of borrowing for the government and that is especially a worry for India, where the fiscal deficit is above 6% of GDP.
- Similarly, higher repo rates also has an impact on the cost of funds for corporates. Most corporates find it more expensive to borrow in the market. Lower rate borrowers have to pay a much higher premium to be able to roll over their loans.
- Rate hikes impacts flows. When rates are hiked, the bond yields become more attractive so global bonds flock to bonds of the economy where rates are going up. Normally, global rate hikes leads to risk off buying, where investors prefer safety of developed markets over the emerging markets.
- Finally, the repo rates also impact equity valuations. A hike in repo rates will hike the weighted average cost of funds of corporates and that means their future cash flows will be discounted at a higher discount rate. This negatively impacts valuations.
Generally, rate hikes by RBI are seen as a monetary tightening policy while rate cuts by the RBI are seen as a move to encourage GDP growth.