The Reserve Bank of India aids commercial banks during a shortage of funds. Repo rate is the rate at which it lends money to the banks when they face a financial crunch. Therefore, when the repo rate is lower, the banks will lend money at a cheaper rate of interest.
According to the latest monetary policy review, the central bank of India, RBI has reduced its benchmark repo rate. This is beneficial if you have the burden of paying housing loan EMIs. Because the reduction in repo rate means banks will lend money at a lower rate. However, it can impact your debt investment or equity funds as well.
How the repo rate impacts investments?
When you take a loan from the bank during a cash crunch, the banks impose a rate of interest. Likewise, the RBI also lends funds to the commercial banks to help them maintain smooth cash flow. Thus, the repo rate is paid by banks to the RBI when they borrow money. If the repo rate is reduced, then the banks will lend money at a lower rate. Reduction in repo rate does not impact your investments directly, but the investments do get affected. Here are some ways in which the repo rate impacts your investments.
Lower repo rate indicates that the commercial banks can lend money at a cheaper rate. Thus, banks will lower their fixed deposit rates as well. When the overall investment rate is low, your returns will also be affected at the time of maturity. However, even with the rise of the repo rate, the interest rates are not increased to a great extent as it may discourage people from investing in fixed deposits. If people stop investing in fixed deposits, then it will cause a liquidity crunch in banks.
Changes in repo rate influence stock prices, which consecutively affects the index prices. When the repo rate is low, the investors can easily take a loan, which results in higher stock prices. Due to the boost in stock prices, the chance of getting higher returns from the mutual fund also rises.
The lower repo rate also makes the funds available at an affordable interest rate, which helps to escalate the demand in the market. Because of high demand, the consumption rate also increases, which determines higher usage. This cycle assures that the market keeps running smoothly. After the reduction of the repo rate, if this cycle continues, the individuals who have invested in mutual funds can expect higher returns.
While RBI reduces the repo rate, some nationalized banks reduce their interest rates on large saving accounts. In most banks, the savings accounts over Rs 1 lakh, gets affected. However, the savings accounts with less than Rs 1 lakh remains unchanged. At the same time, the repo rate will affect the interest rate on several short terms loans as well.
The change in the repo rate affects every area of the economy. The Reserve Bank of India changes the repo rate to control inflation in the market and to maintain liquidity in the market. Owing to the slow market growth, the equity market takes the repo rate cut positively. The companies can access funds at lower rates, which encourages them to borrow more, and results in a hike in investments as well as cause overall industrial growth. This may result in increased consumption that is needed to combat the current slowdown in the economy.