Every month installments (EMIs) are expected to rise as Reserve Bank of India (RBI) announced a surprise repo rate hike by 40 basis points amid high inflation levels.
In its first unscheduled rate change since the depths of the pandemic, the Reserve Bank of India increased its repurchase rate to 4.40%, from the record low 4% its been held at for the past two years to support the economy.
The EMI of a floating rate loan changes with changes in market interest rates. If market rates increase, the repayment increases. When rates fall, the dues also fall.
When the Central bank hikes interest rate or the repo rate — the rate at which banks borrow from the RBI — loans for the customer will become expensive because of the hike in the interest rates by Banks.
This is because banks acquire funds from the central bank at higher prices, which forces them to bump up their lending rates.
“RBI has raised the repo rate by 40bps with immediate effect and CRR by 50bps by 21st May 2022. The rate hike was much-anticipated factoring rise in food and general inflation. The rate hike is likely to shrink liquidity in the economy overall. As per as the banks are concerned the cost of funds is likely to increase so does the cost of deposits,” said Ajit Kabi, Banking Analyst at LKP Securities.
The Reserve Bank has also announced a hike in cash reserve ratio (CRR) by 50 basis points to 4.5%, effective May 21, which will take out ₹87,000 crore liquidity from the system. CRR is a percentage of a bank’s total deposits that it needs to maintain as liquid cash.
Persistent inflation pressures are becoming more acute, Governor Shaktikanta Das said in an online briefing, adding that there is a risk prices stay at this level for “too long” and expectations become unanchored. The bank’s next scheduled rate decision isn’t until June 8.
RBI policymakers have begun signaling recently that higher rates were in the works as consumer prices breached the upper limit of the bank’s target through the first quarter of 2022.
The move also comes ahead of the Federal Reserve’s rate decision on Wednesday, which is expected to see the U.S. central bank’s most aggressive action to battle inflation in decades.
Increases in fuel and food prices, exacerbated by Russia’s invasion of Ukraine and sustained pandemic-related supply chain disruptions, have run hotter than the RBI had expected for much of this year. Headline inflation in March rose to a 17-month high of 6.95%, riding above the RBI’s 2%-6% target range for a third month.
After reaffirming its accommodative stance in February — a step criticized by some economists as too benign on the risk of rising prices — the central bank said last month that it would begin prioritizing inflation over supporting growth.
The RBI in April raised its inflation forecast to 5.7% for the fiscal year that started April 1, up from its 4.5% in February, and said it sees gross domestic product growth during the year at 7.2%, compared with a previous expectation of 7.8%.