RBI’s rate-hike cycle may turn into an easing cycle; there are expectations of rate cuts starting globally, in the U.S., eurozone and other economies, sometime in the first half of 2024.
To gauge the movement of your existing loan interest rates in 2024, the first criterion is whether it is a fixed or floating rate loan. In a floating rate loan, the rate would move as per the underlying variable. However, it was not smooth earlier. Things improved subsequent to a Reserve Bank of India (RBI) circular in September 2019.
Previously, one of the pet peeves of bank loan customers, and rightfully so, was that banks were quick to raise loan rates when interest rates rose but slow to reduce when rates were easing. In those days, floating rate loans were linked to a benchmark internal to the bank.
An external benchmark is one, the fixing of which is not decided or influenced by the bank. RBI repo rate i.e. rate at which RBI lends to banks for one day at a time, is decided by the Monetary Policy Committee (MPC) of the RBI, hence external to the bank.
If bank loans are benchmarked or linked to an external parameter, changes in interest rates have to be passed on quickly to customers. Historically, when the rates in the economy are sliding or the RBI is giving a signal by reducing the repo rate, banks are often slow in passing on the benefit to existing customers. When the interest rate is rising, banks are relatively fast to react. If the benchmark is external, the bank does not have any control and the reset of loan rates will be more equitable. As per the September 2019 circular, from October of the year, all new floating rate loans should be linked to either the RBI repo rate, or Treasury Bill yield of 3- or 6-month maturities. The bank will charge a margin for costs and expenses.
The circular states rate reset must be done at least once in three months. Hence, the transmission of loan rate changes to the client would not be delayed for long.
Expectations for 2024
There are expectations of interest rate cuts, which are expected to start globally in the U.S., eurozone, and other economies, sometime in the first half of calendar year (CY) 2024. That does not have any direct relation to your loan interest rates. This is one of the many variables considered by the RBI for interest-rate decisions. RBI’s rate cuts are expected sometime in the second half of CY2024. The most important criterion for RBI is inflation trajectory. As and when RBI eases the repo rate, your floating-rate loans will be reset accordingly. If the external benchmark is the Treasury Bill yield in the secondary market, it will react to RBI rate cuts. Rather, the secondary market reacts in anticipation of RBI moves and starts easing, to a partial extent, even prior to the rate action. Whatever the external benchmark, the floating rate loan rates are expected to ease in 2024.
In perspective, the RBI raised the repo rate from 4% to 6.5%, from May 2022 to February 2023. External benchmark-linked rate (EBLR) has moved up by a full 2.5 percentage points in this cycle. The other benchmark is the marginal cost-based lending rate (MCLR). MCLR also is reset at a frequency of 6 to 12 months, depending on the bank. Over this phase, till October 2023, median MCLR had moved up by 1.56% i.e. by an extent lesser than EBLR. Weighted average lending rate of banks, on fresh loans, had moved up by 2%.
However, there is a caveat. Things move in cycles. The equity market goes in cycles, the economy goes through cycles, and same is the case with interest rates.
What we are talking about here is the possibility of a cut in the repo rate from the current 6.5%, starting sometime in the second half of CY2024. To be noted, the forthcoming rate-cut cycle is expected to be shallow, say 0.50-0.75 percentage points. The reason is that it is a function of the inflation level and the MPC’s reading on maintaining the repo rate somewhere higher than inflation. The other aspect is that sometime in the future, after the easing cycle we are talking of, the interest-rate cycle will turn upwards. The RBI’s transparent process ensures that when the rate rises or falls, it is passed on quickly to floating-rate loans.
Surplus deployment
The other aspect, from your perspective, is deposits and other interest rate-related investments. Since we are talking about the possibility of RBI’s interest-rate cuts sometime in 2024, it makes sense to make longer-tenure investments.
The current rates are relatively higher. A longer horizon will help you ride out of the easing cycle. You can book bank deposits for longer tenures. If you invest in bonds/debentures directly i.e. not through the mutual fund route, you can buy somewhat longer maturities to enjoy the currently available levels.