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The Rbi Hikes Interest Rate And Keeps The Door Open For Further Hikes

By - Dimple Majithia on January 5, 2023

Executive Summary

The Reserve Bank of India (RBI's) rate-setting panel, the Governor Shaktikanta Das-headed Money Policy Committee, has raised the benchmark interest rate by a total of 190 basis points (bps) in 2022, in conjunction with major central banks' battling against soaring consumer prices. Central bankers in major economies across the globe have a difficult task at hand – balancing inflation, or the pace of increase in the price that a consumer pays for a commodity, with just enough supply of money so that it does not further hamper the economy, two and a half years into the pandemic. 

Background

To combat inflation, now for the fourth time in a row, the RBI’s monetary policy panel has hiked the key lending rate, also known as the Repo Rate, and interest rates by 35 bps to 6.25%, joining a long line of financial institutes and central banks which have done the same to combat the effects of a surging dollar and rising costs. Listed below is the Repo Rate increase history of 2022: 

  1. The RBI raised the Repo Rate by 35 bps on December 7, 2022, bringing the rate up to 6.25% and marking the fourth hike or Repo Rate increase in 2022. 
  2. Earlier, RBI increased the Repo Rate by 50 bps to 5.9% on September 30, 2022. 
  3. In the current fiscal year, the RBI has increased the Repo Rate four times. 
  4. The central bank had also raised the Repo Rate to 5.4% earlier on August 05, 2022. 
  5. The Reverse Repo Rate remains at 3.35% after the announcement, while according to the recent RBI Repo Rate news, the new repo rate is now 6.25%. 

The impacts of Repo Rate hike on various aspects have been listed as under: 

Impact on Economic Growth

Unplanned negative effects on economic growth, even though these measures are essential to tackle inflation. Due to the rise in the RBI monetary policy repo rate, people may purchase increasingly fewer goods and services, which could potentially affect demand and, in turn, slow the growth. As a result, as everything becomes more expensive, goods and services may no longer be within the means of the underprivileged sections of society. 

Impact on Inflation

India could experience economic stagnation by the end of the upcoming fiscal year, even though this decision was made exclusively to combat inflation. However, this might only occur if the inflation-growth scenario does not improve. Additionally, inflation is anticipated to tone down due to these price increases, which would allow the RBI to take a break. Regarding policy rates, it is also thought that the economy is approaching a peak and that the likelihood of further RBI repo rate hikes is low. 

Impact on Loans & EMIs

As banks raise interest rates, existing borrowers may experience a rise in EMIs, which will dampen their enthusiasm about becoming homeowners,vehicle owners, studying overseas, and so on. A rate increase of any size affects consumers because it makes borrowing money from commercial banks more expensive. Additionally, a higher cost of borrowing deters the average person from making unnecessary purchases, which lowers the consumption of goods and services. As a result of which, this enormously influences both the supply and demand chains. 

Impact on Deposits & Fixed Deposit Rates

A rise in the interest rates on bank deposits is good whenever the repo rate rises. Short and medium-term investments such as fixed deposits and savings may benefit from higher rates because they will receive higher returns from their investments based on how banking institutions accept the fresh interest rate increase. 

Impact on Mutual Funds

Investors in mutual funds, particularly those who invest in debt mutual funds, mustexercise caution due to the RBI's recent increase in the repo rate. Toughening interest rates can stifle investor confidence in the debt and stock markets.

Impact on Savings

For individuals having savings and fixed deposits, higher rates are advantageous. Over the past few years, the RBI has increased rates a few times, including one unexpected increase of 140 basis points that brought the benchmark repo rate to 5.40%. 

Impact on Consumer Spending   

People are discouraged from making large purchases when borrowing costs rise, which reduces the demand for goods and services. This disturbs the supply and demand chains, say experts. Therefore, numerous goods and services might see a price increase and eventually become out of reach for the less fortunate sections of society. 

Conclusion 

In response to changing macroeconomic factors, RBI continuously modifies the repo rate and the reverse repo rate. Every time the RBI changes the rates, it affects all the economic sectors in diverse ways. 

[1]Source: If you wish to read further, you can find the complete press release by the RBI  here. 


[1] Click to read: Reserve Bank of India - Press Releases (rbi.org.in)


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