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What the credit policy means to you

Poornima Mohandas in Mumbai | April 26, 2005

Most non-finance professionals may not give even a cursory glance to the Reserve Bank of India's annual policy statement, which typically comes out in April every year and the mid-term review, which follows in October/November.

Although most of what the RBI governor announces may sound Latin to the common man, there are a few things in these policy statements that has a bearing on every investor and borrower in the country.

You can get an idea of how interest rates are expected to move from the policy. The governor may carry out a clear-cut hike or slash in the key interest rate, which is currently the reverse repo rate. Remember that all interest rates in the economy sway in the same direction although with some lag effect.

The interest rate on your fixed deposit or on your home loan are all likely to move up quickly if the reverse repo rate is raised by a substantial 50-100 basis points (one basis point in one-hundredth of a percentage).

However, a smaller hike by say 25 basis points may not lead to any immediate increase in deposit or loan rates but it still signals the general direction in which rates on these products are headed. If you have invested in debt mutual funds there could be a knock on your monthly NAV.

Sandesh Kirkire, CIO-debt, Kotak Mutual Fund says, "If there is a reverse repo rate hike by say 25 basis points one can expect a loss in the monthly NAVs if the funds are invested in longer term government securities. But there will be no drop in NAVs of funds invested in shorter term papers. Most funds today are invested in shorter term papers of below three years maturity."

So what is the reverse repo rate? In recent times it has become the key overnight interest rate. It is the interest rate that a bank earns for lending money to the Reserve Bank of India in exchange for government securities.

Suppose the reverse repo, currently pegged at 4.75 per cent, is hiked by say 25 basis points lets understand what the fallout could be.

In a matter of days, interest rates in the government securities market would nudge up and, if the rise was significant, say by 40-50 basis points banks may then soon consider hiking loan rates and deposit rates.

So you could opt to lock into a fixed interest rate home loan just as a reverse repo rate hike is announced. You could also decide to renew your fixed deposit since the present rate may be more attractive.

At times the Reserve Bank of India may not touch the key interest rate but it may drop broad hints on where interest rates are headed.

For instance the governor might say interest rates are likely to be neutral/harden in the short to medium term. This can be interpreted as a sign of things to come and you could be the early bird to take pre-emptive action on your borrowings and investments.

Other things that may perhaps come in this year's policy, to be announced on April 28, are a freeing of savings deposit rates, the last of the administered rates and a free hand to link fixed deposit rates with a debt market benchmark such as the Mumbai inter-bank offered rate.

Freedom to fix the savings account rate at the individual bank level will mean good times for savings account holders with one bank offering a better rate than the other.

The key indicators

  • The interest rate on FD or on home loan may move up quickly if reverse repo rate is raised by a substantial 50-100 basis points
  • A smaller hike of 25 basis points may not lead to any immediate increase but still signals the general direction in which rates are headed.
  • One could opt to lock into a fixed interest rate home loan just as a reverse repo rate hike is announced.

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Number of User Comments: 1




Sub: meaning of reverse repo rate

i want to know the meaning of reverse repo rate ,its mechanism and its importance to the economy.


Posted by elina




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