What Happens When RBI Hikes Repo Rate? Check the 5 Major Impacts on You

The Reserve Bank of India (RBI) recently decided to keep the Repo Rate unchanged at 6.50%. Previously, to tackle inflation, the RBI had raised this key lending rate four times in a row, with the last increase being by 25 basis points.

Be aware that RBI’s Monetary Policy Committee (MPC) is responsible for deciding these rates This committee is made up of six members: three from the RBI and three external experts. In the last decision to raise the rate, five out of six members voted in favour of the increase. Whenever RBI hikes the repo rate, it affects you in several ways. Let’s check out the 5 major impacts of a rate hike.

• A hike in the repo rate increases loan interest rates and leads to higher EMIs.
• Higher repo rates benefit depositors as it increases interest on fixed deposits and savings accounts.
• Due to a hike, debt mutual fund investors face losses due to a fall in the value of bonds.
• Multiple repo rate hikes reduce consumer demand and slow down economic growth.

The primary reason for increasing the repo rate is to control inflation. It makes borrowing more expensive, which reduces excessive demand. Generally, RBI pauses further rate hikes once inflation stabilises.

However, if inflation doesn’t ease and economic growth slows simultaneously, India might face a period of economic stagnation. In this scenario, prices remain high, but growth stalls. For now, the chances of further repo rate hikes seem limited as the economy is nearing a point where additional increases might no longer be necessary.

When RBI hikes the repo rate, it significantly influences the economy and personal finances. Changes in this key interest rate affect borrowing costs and return on savings. For more clarity, let’s check how the repo rate impacts various aspects of your financial life:

 

1. Impact on loans and EMIs

When the RBI raises the repo rate, banks also increase their lending rates. This makes loans like home loans, car loans, and personal loans more expensive. In such a phase, borrowers with existing loans see a rise in their monthly EMIs.

Also, potential borrowers hesitate to take on new loans. Higher interest rates discourage them from unnecessary borrowing. This leads to reduced spending on goods and services, which slows down economic activity.

 

2. Impact on fixed deposit rates

When RBI hikes the repo rate, it usually leads to higher interest rates on bank fixed deposits (FDs). This is beneficial for depositors, as they can earn better returns on their savings. However, this increase in deposit rates usually takes some time to reflect as banks adjust gradually to the new rates.

 

3. Impact on mutual funds

When RBI hikes the repo rate, it impacts mutual funds, especially debt mutual funds. Higher interest rates lower the value of bonds, which are the core investments in debt funds. As bond prices fall, the returns on these funds also decrease, which leads to losses for investors.

Some cautious investors even withdraw their money from debt mutual funds to avoid losses and shift it to higher-rate fixed deposits.

 

4. Impact on savings

Higher repo rates encourage banks to offer better returns on their savings products, such as annuity schemes, savings accounts, and short-term FDs. This allows depositors to earn more on their savings. For savers, this is a positive development as it increases the returns on their investments without additional risk.

 

5. Impact on economic growth

If we talk about the economy, an increase in the repo rate negatively impacts economic growth. This effect is felt even more when RBI hikes the repo rate multiple times in a short span. Although the RBI raises rates to control inflation, the side effect is that “borrowing becomes costlier”. Consequently, it leads to a reduction in consumer spending.

As people buy fewer goods and services, demand in the economy drops and slow down the overall growth. This reduced purchasing power affects lower-income groups the most, as higher prices make basic necessities less affordable.

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