Globally, central banks are reducing interest rates; though the Reserve Bank of India (RBI) is yet to commit, there are widespread expectations of interest rates easing going forward
There are multiple fundamental reasons for easing of interest rates going forward. Our inflation is lower than earlier. Globally, central banks like the U.S. Federal Reserve and the European Central Bank, are reducing interest rates. Our currency exchange rate is relatively stable. The timing of initiating rate cuts depends on the RBI; a cut may likely happen in December.
Impact on loan rates
Your floating rate loans from banks are usually benchmarked to an external variable. This variable could be the repo rate decided by the RBI, or the yield level on a 3-month or a 6-month Treasury Bill. Basically, floating rate loans are benchmarked to a parameter not under the bank’s control. The implication is, as and when the relevant variable e.g. RBI repo rate rises or slides, the transmission to loan rates happen immediately.
Assuming the RBI cuts repo rate, floating-rate loans are going to get cheaper. Then, you have two options. One, to keep EMI amount same and reduce loan tenure. Two, to reduce the EMI amount and keep the tenure same. The better option is to keep the EMI same and reduce the tenure. The reason is, the longer the tenure of loan, the more interest you end up paying. Though reduction of the EMI amount psychologically seems to be better and easier on cash flows, you are better off finishing it off earlier.
For fresh loans, low floating rates seem attractive and you sign up for a EMI as per your payment capacity. To recall, during or just after the COVID phase, when interest rates were very low, floating interest rates for housing loans had gone down to as low as 6.50 per cent.
Your EMI, worked at that rate, comes to a certain amount. However, your loan tenure is long, say 10 years or 15 years. Interest rates move in cycles. Since then, rates have risen and now we are talking of interest-rate cuts.
The point is, when you are initiating a loan, rates may be low. Over the medium to long term, floating rates would climb. Then, you would have to either raise the EMI or increase the tenure of loan. Similarly, in December or early next year, if rates slide, you should commit to it as per your capacity, assuming it may climb. When floating housing loan rates were as low as 6.5 per cent, banks were not even talking of fixed rate loans.
Interest rates on such loans were very high and the differential with floating rate loans was stark. The reason was banks were aware that the interest rate cycle could turn and they had to protect margins.
Impact on deposit rates
As and when RBI signals lower rates by reducing repo rate, currently at 6.5 per cent, deposit rates would come down. To what extent the rates slide is banks’ commercial decision but would be somewhere around the extent of reduction of the repo rate. If the RBI reduces repo rate by say 0.5 per cent or 0.75 per cent, reduction in deposit rates would be somewhere around that. Obviously, the deposit rates currently available are attractive from this perspective.
Other deposits
There are other interest- bearing instruments e.g. Small Savings (popularly known as Post Office Schemes), RBI Floating Rate Savings Bonds, certain government-sponsored retirement schemes, deposits taken by corporates / NBFCs, government bonds, corporate bonds, etc. The movement of interest rates in all these would be in a similar direction with differences in extent and timing. In any deposit or bond, you are better off locking in now and you would gain in terms of ‘opportunity cost’, i.e. going forward, rates would be lower.
Mutual funds
Mutual funds are market- related investments and there is no commitment like in a bank deposit. In debt MFs, when interest rates slide, returns would be higher. Interest rates and bond prices move inversely. There is an NAV in MFs announced every day, calculated at market prices. However, the market works in anticipation of forthcoming moves, unlike deposit or loan rates, that react to RBI moves. Part of rate easing has already happened. The yield on the benchmark 10-year government bond has eased from 7.38 per cent about a year ago to about 6.75 per cent now.
Conclusion
The net impact of interest rate movements depends on which side you are. If you are a borrower, lower interest rates help. If you are a saver/depositor, they do not. If you are a saver, there is only one indirect positive spin-off. The RBI would reduce interest rates only when inflation is low. In that sense, the real (inflation adjusted) return is not impacted adversely.