Posted On Monday, Mar 09, 2015
The RBI reduced the Repo rate by 25 basis points (bps) to 7.5% on Wednesday, 4th March, 2015. This is RBIs second rate cut in a span of two months. To recap, the RBI had cut rates by 25 bps on 15th January, 2015. Our initial call was a 50 bps cut post a good budget outcome. With the two tranches now, the repo rate now stands lower by 50 bps.
Repo rate, along with the reverse repo rate, marginal standing facility rate and bank rate is a “policy rate” which the RBI controls from time to time, in accordance with its reading of the economic and monetary situation. Any change in the policy rates has repercussions in the lending environment and the broadly the financial markets. And ultimately to end consumers as well; this mostly means good news for you...
Interest rates expected to get even lower
We now expect another 25 bps cut in the June policy review. As by that time, the official MET department forecast would have also been released. We must add that an initial report by SKYMET has said that India would receive normal rainfall this year.
Potentially, the Repo rate can go down to 7.0% by the end of the year; and we add two provisos to it
• Oil prices remain below $75/barrel (the government has budgeted it at a $70/brl for its subsidy calculations)
• INR remains within the 60-64 band.
Post June, if the above conditions hold, the RBI then would have room for another 25 bps cut by October. To finally take the Repo rate down to 7%. Also, if the CPI index follows on the current trajectory; might dip below 4% during the June quarter. Which then gives RBI more than the required space.
CPI would decide the interest rate path ahead
At 7% though, further rate cuts would depend on what the average CPI inflation holds at. The CPI inflation has to average below 5.5% for the RBI to be able to cut below the 7% mark.
Since the CPI has 45% weight in Food; we believe that CPI forecasting will have to undergo an annual exercise, and visibility beyond a year will be difficult as the CPI index will be sensitive to -
2. MSP prices (minimum support prices for farm produce)
Now both these are annual phenomenon and thus any potential range forecast will depend a lot on the assumption on these two factors. The RBI has been very clear that it will be comfortable with a ‘Real Repo Rate’ of 1.5% - 2.0%.
Impact on your loans, investments and the rupee
Good news – bank lending rate cuts should now begin. We would be surprised if there is no action by the banks in cutting their lending rate following RBI repo rate cuts. Till the time the banks cut interest rates on their home loans/ auto loans and corporate loans, the real benefit in the economy would not be visible.
As EMIs on home, car and personal loan would come down in the coming months, for new borrowers it might be prudent to choose floating rate loans as against fixed rate ones. Even if the entire quantum of the rate cut, i.e. 50 bps, may not be passed on to consumers some of it certainly will.
However there's also some not so good news… interest rates on your deposits would also lower. Often in such scenarios deposit rates are cut sooner than lending rates are lowered. Depositors might want to lock in current interest rates for the long period before rates fall further.
On the bond markets, we had suggested post the RBI cut in January, that bond yields have scope to fall further as they should price in the Repo rate at 7.25%. We are getting closer to that. As interest rates fall, existing bonds with higher coupons (or interest) would get attractive and fetch more value. Investors in debt mutual funds investing in bonds would stand to benefit as the rates go down.
The INR should trade positively; but given the large buying by RBI since INR broke below 62; we don’t see any appreciation and RBI will keep trying to push the INR above the 62 level. We expect some large reported increases in RBI FX reserves in the weeks to come.
Do consult your financial advisor for more guidance on your investments.
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