Simplified Laws Guide to Taxation and Legal Concern Reserve Bank of India (RBI) increased the Repo Rate to 6.25% on 7th December 2022.
How does it impact the borrowers and deposit holders?
For the borrowers, an increase in the interest rate hurts but the depositors cheer up! Usually, the father is a depositor and the son is a borrower, so in a family the balance sheet tallies! The only difference is that existing deposits won’t get the benefit of higher interest whereas loans will get adjusted to the new rates (called floating rates), resulting in a net higher outflow.
The impact of higher interest can be understood with three points: Inflation – Interest Rate – Recession
Inflation: To make things simpler, here is a question. Post covid, are you facing a general increase in the prices of goods and services? The spike in hotel bills (what was costing Rs.600 has become Rs.900); fuel prices, salary cost, hotel room tariff, airfare, etc.? If so, call it inflation.
The current consumer inflation rate in India is 6.77%, which means the goods which were costing Rs.100 in Nov 2021 are costing Rs.106.77 in Nov 2022. But this is not the exact way to calculate the inflation because food inflation is high, fuel inflation is high, but some other items may be less expensive. So, the overall/average is around 6.77%
Interest Rate: Soaring prices are not good for consumers; 90% of the citizens are from the poor and lower middle class and live a hand-to-mouth existence. The Government and Reserve Bank of India must curb the increase in prices and lower the cost so that the general public can breathe a sigh of relief.
One of the measures taken by the Reserve Bank of India (RBI) through monetary policy is to increase the interest rates on the borrowings by the Banks from RBI. This is called Repo Rate. When banks like SBI or HDFC borrow from RBI at a higher interest, they have to pass the pain to the end users, i.e., borrowers.
Those who have borrowed money for housing, cars, personal finance, working capital, term loan, project loan, etc., will end up paying higher interest, I mean higher monthly installments (EMI). Banks offer two ways to adjust the higher rate, either you pay a higher EMI (say, instead of Rs.10,400 per month, about Rs. 10,900 per month) or keep the EMI as same, but increase the loan tenure (say, instead of 10 years of the loan term, it will increase to 11 years). In both cases, the consumer will pay interest payout.
How will it help reduce the prices of commodities?
With the old EMI, you would have had higher disposable money to buy other stuff. Now, with the increase in the EMI, the cash in the hands of consumers will be less, and thereby, they will not buy goods as much as they were buying earlier. Instead of going to restaurants thrice a month, they will go twice a month.
Secondly, new borrowers will either postpone the requirement or prune the budget, thereby reducing the money supply in the market. Lesser the money supply, the lesser the demand. Common sense, right?
Recession: Will it not reduce the demand?
Exactly. When people start consuming less, the demand comes down and thereby the prices tend to ease/reduce. The flip side is that lesser demand leads to reduced production of items by the producers/companies. This will result in a mild recession. This is like taking an injection when you are ill. Though it causes pain, it is required to cure.
The general public can’t afford the higher cost of living and taming inflation is an injection that will induce short-term pain in the economy. But slowly things will get normalized.
The impact: The immediate pain is two-fold for the companies or service providers. They will have to pay more for the loan and the demand for their goods/services will be less. It is going to be a double-edged sword. So, business stay put and you will pass this difficult phase soon.
A word of caution to all borrowers; try to borrow within your means, not drown in debt up to the brim! A situation like this will upset your equation, in a way, it will appear more like surgery than a mere injection. Borrowing is an art, craft it carefully.
