- After a small jump of 40 basis points in May,
RBI traveled theinterest rate by another base of 50 in its attempt to fight inflation. - If the RBI expects inflation to exceed its tolerance limit, it increases the rate at which banks borrow money from the central bank.
India’s central bank Reserve Bank of India raised its repo rate for the second consecutive month, from 4.4% to 4.9% on Wednesday.
After a small jump of 40 basis points in May, RBI raised the interest rate another 50 basis points in its bid to fight inflation.
For the month of April, consumer price inflation reached 7.8%, digging a hole in the pockets of the common man.
But why exactly is the Indian central bank raising interest rates? How does this reduce the expense burden of ordinary people like you and me? Let’s find out.
What is
Before we dive into that, let’s understand what exactly repo rate is.
The repo rate stands for “call option or buy-back agreement”. It is the rate at which commercial banks and financial institutions like SBI, ICICI Bank, HDFC Bank and others borrow money from the central bank.
Why is the repo rate increasing?
If the RBI expects inflation to exceed its tolerance limit, it increases the rate at which banks borrow money from the central bank.
Over the past three months, retail inflation figures have remained above the RBI’s upper tolerance limit of 6%. The last time inflation was below 4% was before the 2019 global pandemic.
When the repo rate increases, the cost of borrowing for banks also increases, which is passed on to their account holders by increasing the interest rate on loans and deposit rates.
It also makes borrowing money from the bank an expensive affair, which in turn slows investment and money supply in the market.
As a result, it limits the money supply and lowers the purchasing power of consumers, which helps control inflation.
The pension rate is reduced when the government intends to inject money into the market and support economic growth, as it did during the lockdown.
In fact, RBI had not increased the repo rate for almost 4 years until last month.
How a Small Repo Rate Increase Affects You
A slight rise in the repo rate makes borrowing from commercial banks expensive.
When the cost of borrowing increases, the common man is discouraged from making unnecessary purchases, thereby reducing the demand for goods and services. This sets off a chain reaction, leading to a reduction in prices and, consequently, inflation.
It is simply a game of supply and demand, with the repo rate acting as a catalyst.
On the other hand, people who have savings and who have a fixed deposit, for example, will benefit from an increase in interest rates. A survey by Stocktwits shows that banking stocks could also benefit from the rise in the repo rate.
Ripple effects of rising repo rate
When business loans become expensive, companies cut back or freeze hiring, leading to unemployment.
Consumers have also put a pause on buying all luxury items, including vehicles, which is affecting the auto industry.
The real estate sector, which was experiencing a good recovery in sales due to the low cost of financing, could be impacted by the rise in RBI rates. As banks raise their interest rates, this will cause a further increase in monthly equivalent payments (EMI) for existing borrowers and shake the confidence of new buyers.
Low interest rates are unlikely to return as the Indian government expects the country’s economy to take at least 12 years to overcome the Covid-19 setback. He said ongoing structural changes catalyzed by the pandemic have the potential to alter the medium-term growth trajectory.
Higher interest rates and inflation put the common man in a soup
The war in Ukraine has greatly aggravated the misfortunes of the common man. It pushed up commodity prices due to geopolitical tensions and affected the global supply chain, tightening financial conditions globally.
As a result, due to import restrictions and high demand for essentials, everything from food and drink to clothing and accessories is expensive today.
Ordinary people in India were already struggling to manage their daily expenses with limited purchasing power on a minimum wage.
Due to this runaway inflation, consumers are losing more purchasing power, which is a measure of how many goods or services you can buy with one monetary unit, at a faster rate than usual.
While the current repo rate of 4.9% is still not as high as the pre-pandemic level of 5.15%, the common man will feel the pinch due to rising inflation. consumer prices.
On Wednesday, the RBI raised its inflation projection for the current fiscal year to 6.7% from 5.7% forecast in April and 4.5% in February.
If the inflation rate continues to rise despite the recent changes in the repo rate, RBI will resort to another hike in a few months to bring inflation under control.
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