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What the cut in repo rate means for you

LiveMint logoLiveMint 02-08-2017 Vivina Vishwanathan

As expected on 2 August, in the third bi-monthly monetary policy statement, the Reserve Bank of India (RBI) cut the repo rate by 25 basis points (bps) from 6.25% to 6%. Repo rate is the rate at which the RBI lends money to commercial banks. One basis point is one-hundredth of a percentage point. Consequently, the reverse repo rate also got adjusted to 5.75%. Meanwhile, the apex bank maintains a neutral policy stance expecting inflation rate to go up from here. Here is a look at what the policy announcement means for your money and what you should do.

The RBI seems to be unhappy with the current benchmark lending rate—marginal cost of funds-based lending rate (MCLR). During the policy announcement, RBI deputy governor Viral Acharya said, “The experience with the MCLR system introduced in April 2016 for improving monetary transmission has not been entirely satisfactory even though it has been an advance over the earlier base rate system.” The central bank is all set to relook MCLR. “We have constituted an internal study group across several clusters to study the various aspects of MCLR system and to explore where the linking of the bank lending rate could be made direct to market-determined benchmarks going forward. The group will submit the report by 24 September 2017,” said Acharya.

This is not the first time that the RBI is considering a relook in the lending rate mechanism. All floating rate loans taken after April 2016 are linked to MCLR. MCLR is built on four components—marginal cost of funds, negative carry on account of cash reserve ratio (CRR), operating costs and tenure premium. Prior to MCLR, floating rate loans were linked to base rate and before that to benchmark prime lending rate. There is a possibility that borrowers are likely to see a new benchmark lending rate that will replace MCLR. However, this won’t happen immediately.

What kind of change can you expect in the benchmark lending rate? “Depending on the asset and liability, they will try and identify different buckets. For instance, they will look at investment rates right from government securities to other comparable investments. They will try and determine those assets that they need to deploy against the liabilities. For instance, for long-term loans, they will look at long-term investments. This will compel banks to become more efficient. Market works far more efficiently than banks. It will put one more burden on the banks,” said Ashvin Parekh, managing partner, Ashvin Parekh Advisory Services Llp.

But what does a 25 bps cut mean for your existing floating rate loans on MCLR? “From a broader perspective, this 25 bps cut has already been priced in. Because if you look at the way banks have moved their deposit and lending rates, banks in a way have priced in this drop. This has been talked about for a while now. We will have to see how deposit rates move for different banks. But in my mind, it is priced in to a large extent. There may be a marginal movement but I won’t expect any major movement. Consumers should be in a happy situation, particularly homebuyers. I think rates have been transmitted. But credit has still been weaker in the corporate segment,” said Shanti Ekambaram, president-consumer banking, Kotak Mahindra Bank Ltd. Banking analysts say that banks are likely to cut lending rates linked to MCLR further. If you are looking to borrow, compare rates in the market and also factor in other charges.

Banks have been cutting deposit rates. Recently, the State Bank of India cut savings account deposit rate to 3.50% per annum. ICICI Bank Ltd has cut fixed deposit rates. “Banks have been dropping deposit rates, if you see in the last few months. I see SBI’s move as it largely comes from sluggish growth. The way credit growth trajectory goes from here, I think it will determine how you see cost of funds move because there is plenty of liquidity in the system. Liquidity and demand supply will be the major factors that will come into play,” said Ekambaram. You can expect further cut in fixed deposit rates.

The capital markets had expected a rate cut. “The RBI has gone ahead and cut repo rate by 25 bps, which was in line with market expectations. With the CPI inflation for June coming down sharply to 1.54%, the market had high expectations that RBI will take steps towards easing rates in the systems. Further, the weakening IIP numbers added more to the expectations and accordingly it seems the RBI has acted. With oil prices likely to remain benign, aided by a stronger rupee, should reduce the volatility associated with imported inflation,” Siddharth Purohit, senior equity research analyst-banking, Angel Broking.

Mutual funds as well as debt funds have been factoring in this rate cut too. “RBI has broadly delivered a textbook kind of a rate cut. I don’t read it as outrageously negative. From a bond market perspective, cost of borrowing will be cheaper now by 25 bps, so carry trade will support the bond yields but it will be a tight range till you get further clues from the inflation front and more specifically how the US yields will behave,” said Lakshmi Iyer, chief investment officer – debt, and head of products, Kotak Mahindra Asset Management Co. Ltd.

“If retail investors are in duration funds already, you should continue to stay put. If you are doing a fresh allocation right now, overweight your portfolio into short-term funds. Two-and three-month asset yields will be anywhere around 6.15-6.35%. Because it is largely pegged to overnight rates and there is a gap between saving account rate and the overnight rate. Investors should definitely buy more comfort with liquid funds over traditional mode such as savings account,” said Iyer.

Research analysts and fund managers have a similar view. “In mutual funds, if you take duration funds such as dynamic bond funds, they have been increasing the average maturity on the portfolio from February to now. The average maturity for dynamic bond funds increased from 7.2 years to 9.9 years between February and June end. We are of the view that retail investors can continue holding duration funds. Expecting high returns from duration funds from here on may not be a good idea. Steady returns from income-accrual funds is the way to go. Liquid funds have been moving in tandem with the market rate. From last 1 year, it has been declining and has been around 6.7% on an average,” said Vidya Bala, head of mutual fund research, Fundsindia.com.

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