How Does Repo Rate Increase Affect Your Finances?

The Reserve Bank of India (RBI) is a statutory body that is directly or indirectly responsible for banking regulation, money supply, inflation management, and issuance of currency. RBI acts as a regulatory body of India’s financial system. It creates a balance between growth and inflation, overheating and slowdown, excess liquidity, and drying up of funds. It also allows commercial banks to obtain funds through a set repo rate.
Read on to understand the effect of increase in Repo Rate, one of the tools used by RBI to carry out its duties.

What Is Repo Rate?

The repo rate is short for Repurchase Option Rate. It is the rate at which the RBI lends to banks in India. This lending is done against collaterals like Government bonds, Treasury bills, etc. In times of fund shortage or urgent funding requirements, banks approach the RBI and borrow money for a specific tenure. They pay interest to the RBI for using these funds, at a rate which is called the repo rate. The RBI can increase the repo rate or decrease it, thereby controlling the overall interest rates prevailing in the economy and also the overall supply of funds in the system.

How Repo Rates Affect Your Finances?

As mentioned earlier, the repo rate is the rate at which banks and financial institutions borrow from the RBI.

What Happens When Repo Rate Increases?

If inflation is running high, the RBI may increase the repo rate, thereby making borrowing costlier for banks and NBFCs. This higher cost of borrowing is subsequently passed on to customers (borrowers) through rate increases. A rise in repo rate increases the interest rate on all types of loans, such as Personal Loan, Business Loan, Car Loan, etc.
Since loans become more expensive, the demand for loans, on the whole, goes down. Hence, people (and businesses) tend to conserve cash, thereby bringing down the overall level of activity in the economy. This results in a reduction in inflation. 

Effects of Reducing the Repo Rate

If the RBI wants to boost the overall activity in the economy, it can reduce the repo rate. This reduces the cost of borrowing for banks and NBFCs, who in turn, pass it on to their customers. Thus, the interest rates on all types of loans go down. This leads to a higher demand for loans, thereby boosting the level of activity in the economy.
Thus, the repo rate is a key instrument for controlling inflation or boosting demand. It also directly affects the interest rate on loans.

RBI Repo Rate Cut History 2019-2023

Please refer to the table below to understand the history of RBI’s repo rate cut since 2019:

As seen in the above table/chart, the RBI resorted to reducing the repo rate as an immediate reaction to the COVID-19 pandemic. Economic activity came to a near-standstill owing to multiple lockdowns; hence it was necessary to reduce the repo rate to boost economic activity. 
Once the economic activity was nearly back on track, RBI raised repo rates once again to prevent the overheating of the economy. This is an example of how the RBI uses the repo rate to tame inflation and boost growth.
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Impact of Repo Rate Hike on Different Scenarios

RBI’s repo rate has a different impact on specific scenarios, which you can read about below:

• Economic Growth

Whenever RBI increases the repo rate, businesses and stock markets take a hit. The increase in the repo rate stops businesses from spending funds for expansion. This slows their growth and negatively impacts a business’s cash flow and profits, which eventually results in a drop in stock prices.

• Inflation

RBI controls inflation by reducing the money supply in India’s economy. This is done by increasing the repo rate, which discourages banks from borrowing money from RBI. 

• Loans & EMIs 

An increase in repo rate will impact your loan EMIs due to the increased interest rate. This happens when financial institutions are charged higher interest rates by the RBI, which also impacts your loan’s interest rate.

• Deposits

The interest rate on deposits is positively impacted by the increase in the repo rate as any hike increases a bank’s requirement for funds. This eventually increases the interest rate on different types of deposits like fixed deposits.

• Mutual Funds 

The stock market is negatively impacted by increasing repo rates, as less capital is available for mutual funds to carry out their operations. Thus, individual stocks along with mutual funds are negatively affected by a repo rate increase.

• Impact on Consumer Spending 

An increase in repo rate can significantly impact your spending as a consumer. Consumer spending on cars, homes, and investments is generally lower in case of a hike in the repo rate as the interest rate on loans also increases.

Conclusion

To conclude, the interest rate on your loan is directly proportional to the repo rates prevailing in the economy. Hence, it is an effective tool available to the RBI for furthering its objectives related to the monetary system. An economy that has a high rate of inflation sees a rising trend in repo rate while an economy that is low on growth sees a declining trend in repo rates. The only solace in a rising repo rate scenario is the subsequent rise in deposit rates!

Frequently Asked Questions About Repo Rate

1.    How much EMI will increase after the repo rate?
It is difficult to predict the exact increase in the EMIs and loan interest rates after an increase in repo rates. However, banks and NBFCs generally pass on the rate hike/decline to customers to stay competitive and profitable. For example, if the RBI increases the repo rate by 50 basis points (1% = 100 basis points), all lenders will increase their loan interest rates by a similar quantum. However, it is extremely unlikely that a lender will take the opposite direction, i.e., decrease the loan interest rate after an increase in repo rate by the RBI.

2.    What happens when the repo rate is increased?
When the repo rate is increased, the cost of borrowing increases for banks and NBFCs. Hence, to protect their margins, they increase the loan interest rate for their customers. 

3.    What is the current repo rate in India? 
As of December 2023, the prevailing repo rate in India is 6.50%.