RBI keeps repo rate unchanged at 6.5% – How can homebuyers reduce their interest burden?

The Reserve Bank of India, in its bi-monthly monetary policy, announced that it will keep the repo rate unchanged at 6.5% - for the ninth time in a row. What does it mean for homebuyers and the economy? We try to answer your questions in this article. But the first thing you need to understand is the repo rate?

What is the Repo Rate?

The repo rate is the rate at which a country's central bank (RBI in India) lends money to commercial banks for short-term purposes. Repo rate is increased or reduced. It is done as a part of the RBI's monetary policy to regulate liquidity, control inflation, and stabilize the economy.

Let us understand how exactly it works. If you want money on an urgent basis - what would you do? You go to a bank and borrow money. Similarly, commercial banks may face short-term liquidity shortages and need funds to meet their daily obligations - withdraw requests for customers or loan disbursals. In such a situation, they can borrow money from the central bank by selling their government securities with an agreement to purchase them at a future date (and hence repurchase or repo rate). The rate at which this transaction happens is known as the repo rate. No point in guessing, but a higher repo rate means that it becomes more expensive for banks to borrow money from the central bank and vice-versa. We will look at how exactly the repo rate impacts the economy.

Historical changes in Repo Rate

At present, the repo rate in India is 6.5% and has remained the same since February 2023. In December 2022, the repo rate was 6.25% and increased in the following MPC. The RBI started increasing the repo rate in May 2022 - before that, the repo rate remained at 4% for a very long time in India. Between May 2020 and May 2022, the repo rate remained 4%.

The repo rate was 6.5% before this in 2018, and it started declining post-August 2018 to settle at 4% in May 2020. In the last two decades, the highest repo rate was seen after the 2008 financial crisis when RBI increased the repo rate to 9% and remained over 5% for a very long time.

Influence of Repo Rate

Let us look at how repo rates impact different areas of the economy:

Impact on Inflation

The repo rate is increased or decreased to check on inflation. In 2022, inflation was reported above the RBI's threshold of 6%. Here is how it works:

• Raising the Repo Rate: To handle the rising inflation, RBI increases the repo rate. When this happens, borrowing becomes more expensive for banks. As a result, banks may raise interest rates on loans to customers (home and car loans), leading to a reduction in borrowing and spending (you may delay your buying if you need to pay high interest). It can help to curb inflation by reducing the overall demand in the economy.
• Lowering the Repo Rate: When the RBI reduces the repo rate, it becomes cheaper for commercial banks to borrow money. The increase in liquidity encourages banks to lend more, which can stimulate spending by consumers and businesses. Increased spending, in turn, can lead to higher demand for goods and services, which might increase inflation if supply doesn't keep pace with demand.

Impact on Economic Growth

A lower repo rate is used to stimulate economic growth. By making loans cheaper, businesses can invest more in expansion, and consumers can spend more on goods and services. Conversely, a higher repo rate is used to control economic growth that is too rapid.

Effect on Loan and Deposit Interest Rates

A change in the repo rate usually leads to a corresponding change in the interest rates of loans offered by banks. For example, if the RBI reduces the repo rate, banks may lower their lending rates, making loans cheaper for customers. Similarly, a lower repo rate might lead to lower interest rates on fixed deposits and savings accounts, making them less attractive for savers.

Impact on Real Estate

Lowering the repo rate leads to lower home loan interest rates, making housing more affordable. Conversely, a hike in the repo rate makes home loans more expensive, potentially reducing demand for real estate.

A recent announcement by RBI on the repo rate

You now have a basic understanding of the repo rate. In the recently concluded Monetary Policy Committee, the six-member panel has kept the repo rate unchanged at 6.5% amid risks from higher food inflation. It continued with the monetary policy stance of withdrawal of accommodation. Four out of six MPC members voted in favor of the rate decision.

Withdrawal of accommodation is a central bank's term for tightening monetary policy. It means the central bank is moving away from the supportive measures it had put in place to boost the economy.

Effect of unchanged repo rate: How can homebuyers reduce their interest burden?

The majority expected that the repo rate would not increase from the current levels. No increase gives relief to home buyers since their home loan EMIs will not increase.

Homebuyers can opt for floating-rate loans. Since it is expected that in the upcoming MPC will reduce the repo rate, it will lower the home loan interest rate and decrease the EMIs. Existing homebuyers can consider refinancing existing home loans to benefit from potentially lower EMIs.

Before you go

The repo rate is a powerful tool for the RBI to manage the economy. Its impact is far-reaching, affecting inflation, economic growth, interest rates, the stock market, real estate, the currency exchange rate, and government borrowing. Investors and borrowers must pay close attention to changes in the repo rate, as it can significantly influence their financial decisions and the broader economic environment. The RBI's next policy review will be keenly awaited, as the repo rate first cut is expected in the next meeting.