There was some good news and some not so good news for borrowers when the Reserve Bank of India (RBI) announced its monetary policy review earlier this month. First the good news. RBI adopted unconventional measures to bring down the cost of funds for banks. It eased the cash reserve ratio (CRR) requirement on incremental loans in the auto, housing and MSME (micro, small and medium enterprises) segments and also allowed banks to borrow money for one to three years at the existing repo rate.
Shorn of the financial jargon, this simply means that lenders have been given access to cheaper funds which in turn could bring down the interest rates for auto and housing loans. This is presuming the perfect transmission of cheaper funding is indeed passed on to borrowers in the form of lower interest rates. The State Bank of India (SBI), one of the biggest mortgage lenders in the country, has already cut its marginal cost of funds-based lending rate (MCLR) and other banks are expected to follow suit. Let’s hope for the best.
If you were planning to take a home loan, or to purchase a car with loan funds, you may now get a lower rate and probably pay a lower EMI. The measure is designed to encourage borrowing and fuel demand. The auto and real estate sectors have indeed been languishing because of weak demand for the past several quarters. If lending rates come down, these sectors could witness a pick-up in sales.
Now for the not-so-good news. Only loans taken between April 2016 and September 2019 are linked to MCLR. Also, these loans are reset every six to 12 months, so there may not be immediate gains for borrowers. SBI’s one-year MCLR is now down by 5 basis points (bps) to 7.85%, but this will come into effect at the next reset date. One bps is one-hundredth of a percentage point.
The bigger concern is that after RBI made it mandatory for lenders to link loans to external benchmarks from 1 October 2019, most loans are now linked to the repo rate. In the recent policy announcement, RBI has not touched the repo rate at all. So, nothing changes for existing loans linked to the repo rate. Unless there is a cut in the repo rate, their loan EMIs and tenures will not change.
But it seems unlikely that the repo rate will be cut. After a long hiatus, inflation has surged above the upper tolerance band of RBI, forcing the central bank to revise its CPI (consumer price index) inflation target to 6.5% for the fourth quarter of the current fiscal year. Therefore, the monetary policy committee of RBI is unlikely to reduce the repo rate, lest it boost inflation further.
There is another collateral damage for investors. The easing of CRR has led to banks cutting interest rates on their deposits. Encouraged by the surplus liquidity, SBI has cut its deposit rates by 10-50 bps. Several public sector banks have also announced rate cuts on deposits.
Investors who had planned to put money in fixed deposits should now consider small savings schemes from the post office instead as the interest rates these instruments give are still quite attractive. The Public Provident Fund (PPF) and National Savings Certificate (NSC) are offering 7.9%, while the Monthly Income Account and Kisan Vikas Patra (KVP) are giving 7.6%. Pensioners, who have been hit hard due to the falling interest rates can get 8.6% in the Senior Citizen Savings Scheme. Moreover, parents of girls below 10 years can invest in the Sukanya Samriddhi Yojana (SSY) to earn 8.4% tax-free returns.
But investors need to move very quickly. The interest rates on small savings schemes are linked to government bond yields and are reviewed every quarter. For some instruments (PPF and SSY), any change in the interest rate will also apply to the existing balance. For others (NSC and KVP), the rate fixed at the time of investment remains unchanged for the full tenure. In the past few quarters, interest rates have not been cut, even though bond yields have declined sharply So, investors should choose the right instruments and lock into the high rates before they are reset.