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How do Interest Rate fluctuations affect us?

You might have thought many times that what does these big economists do and how does their decisions affect us…..? So this time we are trying to take you through some of the main concepts of economic policies and the affects of those on each of us the so called “Aam Aadmi”. So basically there are two kinds of economic policies taken by a Govt. or regulatory bodies, such as Monetary and Fiscal policies. Monetary policies are those which a central bank or government of a country takes to keep a control on demand and supply of money with an objective of attaining growth and stability of the economy.

Recently RBI the central Bank of India announced its monetary policies. Before going into the reasons and impacts of that, let us understand what policy rates are and what is the impact they can directly have on other rates like home loans, personal loans and lending rates…?

What does Policy rates mean?

In simple words Policy rates are the monetary tools of RBI (Reserve Bank of India) which it use to control the money supply in the country, determining and maintaining day to day liquidity in the system and to determine other bank rates. Some of the key Policy rates are given below;

  • Cash Reserve Ratio (CRR)
  • Repo Rates
  • Reverse Repo Rates

Cash Reserve Ratio (CRR)

All the banks have to maintain a certain percentage of cash deposits with RBI that amount of funds are called Cash Reserve Ratio (CRR). Increase in the rate of CRR means Banks have to park more money with RBI and the funds available with banks will come down. RBI increases the rate to pull out excessive money from the banks and to maintain a balance.

Repo Rates

This is the rate at which Banks borrows money from RBI. It’s the lending rate of the central bank. So if central bank increases the Repo rate it is not good news for banks as they have to borrow money at high cost. This compels banks to increase their lending rates as they get money at high rates.

Reverse Repo Rates

Reverse Repo rate is the opposite of repo rate. It means the rate at which RBI borrows funds from the banks. If RBI increases this rate its good for the banks as they get higher returns by lending money to RBI.

So these are the basic policy rates which are very crucial not only for the economy but also for a common man because who is going to be effected ultimately.

Recent Increase in the Policy rates

Recently RBI has hiked CRR by 25 basis points, Repo rate by 25 basis points and Reversed Repo Rate also by 25 basis points. Due to this move by RBI 12500 crore of excess funds will be pulled out of the Economy. But this move has raised our eyebrows as on the one hand country is facing inflationatory pressure and on the other hand economic recovery is under way. So how effective is this move, we all have to wait and watch.

Recent Increase in the Policy rates

In Charts

What is the reason for Increase in Rates?

First reason to increase rates is to tame inflation. You can see the rising trend in the Inflation in India, so to control this RBI has taken this step. Second reason is to pull out money from the system- As the recent data on Industrial Production and Growth shows that Economy is on the recovery path and system has enough liquidity with good credit growth backup so according to RBI it is the right time for normalization of monetary policy.

What are the impacts of Rate hikes?

As on the macroeconomic fronts we have discussed a lot but now its time to see how a common man will get affected from this move of RBI.

  • Impact on Home loans
  • Impact on your loan installments
  • Impact on Car loans
  • Impact on inflation

Impact on Home loans

As we saw after the hike in rates in March, many banks have hiked the interest rates for home loans. The trend will remain the same and shortly we can see a hike in interest rates on the bank Home Loans.

Impact on your loan installments

RBI has decided to follow tight monetary measures and increased the rates; rate hikes will have an adverse impact on the long term payments of the loans as it may affect your monthly installments (EMI).

For example; If you have a loan of 50lacs for 20 years your repayment may go up by nearly 10 lakhs if the rate goes up by 1 percentage. So you can think of the impact of mere rate hikes in long term.

Impact on Car loans

If you are planning to buy a new car it is not the right time to do so. There are two reasons first is the impose of excise duty by Government in budget and other reason being the recent hikes in interests on car loans by the lenders. They have increased the rate by 75 to 100 basis points.

But on the contrarily it can be the best time for buying a Car as the interests are going to be high in the near future.

Impact on inflation

In the figure we can see how the inflation has raised from negative to near double digits. As the rate hikes are lower compared to the high level of inflation so the question arises will this hike be able to make any impact on the inflation?

The hike is basically to strike a balance between growth and inflation. Although this move will curb inflation but the current inflation is dependent on various other factors as such monsoon, food inflation, crude oil price and state of global economy.

Will this have any effect on the Investments?

As system still has enough liquidity, rate hike will not have any adverse effect on the investment part. In addition to liquidity the credit availability is good for the retail investors. So this rate hikes will take money out but still the investments will not be affected in short run.

We have already discussed about the reasons, trends and impact of Policy rates of RBI on economy and common man. But what should one do in near future considering the state of economy and policies of RBI. It is very much clear that this move is the normalization of monitory policy, not tightening of it. So you have to keep in mind that interest rates are going to be on the rising trends and consider this as an opportunity to get home loans and car loans as the rates will go up in the future.

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Deposits and Bank Accounts
Fixed deposits
Reverse Repo Rate Repo Rate
November 2008 6.00% 7.50%
December 2008 5.00% 6.50%
January 2009 5.50% 5.50%
March 2009 3.50% 5.00%
April 2009 3.25% 4.75%
March 2010 3.50% 5.00%
April 2010 3.75% 5.25%