The RBI and the Monetary Policy Committee came up with an expected but unscheduled move on 4th May 2022, increasing the repo rate by 40 basis points to 4.40% and increasing CRR (Cash Reserve Ratio) by 50 basis points to 4.50%.
Here’s why the RBI took this stance
Heightened inflation globally is an alarming situation that is spreading fast. Geopolitical tensions have caused an increase in Inflation. Inflation is at the highest level in four decades, in the United States.
Here are some factors compelling the RBI to re-visit the policy.
- International crude oil prices are hovering above $100 per barrel, tempting domestic pump prices to an all-time increase.
- Global food prices have been steadily increasing since October, touching a new record high in March 2022 due to global wheat shortages.
- Inflation breached the upper limit of 6% in the last three months, above the RBI’s target. CPI (Consumer Price Index) touched a 17-month high of 6.9% in March, while WPI (Wholesale Price Index) stood at 14.55%.
- Liquidity in the market is in surplus, causing elevated inflation. To crunch this liquidity from the economy interest rate needs to be revised.
So, the interest rate cycle has finally started, and rates are likely to move further up. What does this mean for your savings, borrowings, and investments? Read on to find out.
Impact on Savings or Fixed Deposits
There has been an outcry about low FD (Fixed Deposits) rates offered by financial institutions. But now the change is here:
The FD investors will now enjoy a little higher rate than the previous one. The rate increase will initially affect the short-term FD rates.
Short-term FD will see a quick change in the rates, and for long-term FD, it will take some time. For long-term investments, investors should wait for another rate hike.
Impact on Borrowings
If you have an existing loan at a floating rate loan, then you can see a marginal hike in the EMI, or you may not see it. As banks usually just increase your EMI tenure, the impact is not directly visible.
If you are looking for a new loan, you will witness a marginal increase in the lending rate by the lenders. It is important to consider applying for a loan before the next hike in interest rate.
Impact on Investments in Equity
Whenever there is an increase in interest rates, the equity market tends to behave inversely. Low-interest rates will lift the equity market, and high interest rates will drag the equity market.
So, if you have invested in the equities, you should reset your expectations from the investments. The market may give lower returns than what you anticipated, earlier, in the short term. However, if you remain invested, you can benefit from the rupee cost averaging out at a lower price.
Impact on Investments in Debt
An increase in interest rates is going to affect the debt market inversely. The short-duration bonds and related instruments tend to provide high returns to their investors.
For the time being, investors should avoid taking positions in long-term debt funds. Investors should consider taking a position in liquid funds, ultra-short duration funds, money market funds, and low-duration funds.
There is no need to worry about short-term policy changes as long as you plan your financials accordingly.
