What the RBI rate cut means for investors as well as borrowers

RBI surprised the street by cutting the repo rate from 8% to 7.75%. Though small, this 'between-the-meetingscut' has given the signal that the RBI is confident of achieving its inflation targets and the focus is shifting towards growth. Since the RBI has always wanted policy action to be consistent with long term rate stance, this cut heralds the start of a new 'rate cut cycle'. Now the only questions are 'how much' and 'by when' these rate cuts will happen. Since most experts (see box) see measured rate cuts, how is it going to impact you?

Investments: The Sensex and Nifty jumped by 729 and 259 points respectively on 15 January, when the rate cut was announced. Stocks from rate sensitive sectors rallied. While the bank Nifty hit a new high, the realty index jumped more than 8%. A lower rate increases purchasing power and therefore, is good for most other sectors as well.

Debt investments can be classified according to how the impact of this cut will be felt. The first part, where the market forces decide the price of bonds, has already rallied based on the expectations of a rate cut after the budget.

The 10-year yield came down by a further 10 bps on Thursday. Most experts are predicting a further fall in the 10-year yield. Long term gilt funds and long term tax free bonds should generate double digit returns in 2015 as well.

The second part includes bank FDs and RDs, where the rates are fixed by the banks. Since this rate has not yet fallen, it still provides a good opportunity to lock in at higher rates. Go for FD if you have enough liquidity; else start an RD.

Loans: To protect their margins, banks first cut the rates on FDs and RDs before reaching for the loan rates. In the recent past, banks have refused to bring their base rates below the 10% mark, despite significant deceleration in loan growth.

Though banks may do some token cuts to pacify the RBI, no major cut in lending rates are expected. Borrowers may have to wait for a few more months for the arrival of the "achhe din".

Since demand for automobiles is weak, the first rate war may start in the auto loan segment. This reduction is possible without tinkering with the base rates because the interest rates on most auto loans are at a significant premium to the base rates. Bargain hard to get a better deal on auto loans.

Since home loan rates are only slightly above the base rates, the reduction will be in line with the reduction in base rates. One should not expect more than 25 bps reduction in home loan rates. This reduction will be only for borrowers who have availed the 'floating rate'.

However, overall home loans rates are going to come down significantly in 2015. Borrowers who can afford to should wait for better rates. The same applies to those who want to shift between lenders now. Wait for a few quarters, let the borrowing rates stabilise at lower levels and then make the move towards the lowest lenders.

Source: The Economic Times