Does the RBI repo rate cut burn a hole in your pocket?

“My name is Raghuram Rajan and I do what I do”

This is what our RBI (Reserve Bank of India) Governor said in reply to a question as to whether he was ‘Santa Claus’ as he surprised the nation by 50 bps cut in the repo rate. He had been criticized by most in India Inc. (Government and Corporates) for not cutting rates earlier. So what does this RBI repo rate cut mean for the common man?

The Basics

The Reserve Bank of India is India’s Central Bank which has a number of functions and responsibilities which includes the monetary policy. One of the functions is to lend money to commercial banks at an interest rate, which is termed as the ‘repo rate’. The bank in turn lends money to companies, institutions and people for the functioning of the economy. Therefore, if the RBI lending rates are lower, that would mean the Banks can reduce the lending rates to its consumers as well! Good news? Yes, conditions apply!

Direct Influences

Banks like SBI and HDFC have already cut lending rates to 9.3 % and 9.35 % respectively. For the aam janata, this has mainly two implications:

1. EMIs come down: Home Loan EMIs, Car Loan EMIs and Personal Loan EMIs come down, meaning more saving for you. Great news! Hold on.
2. Deposit rates fall: But the flip side is that deposit rates will reduce as well. So those of you who are safe investors and happily direct your savings to Fixed Deposits and Recurring Deposits will find your returns shrinking hence you need to re-think your strategies.

What strategies can one implement?

To answer this, we need to analyse the other repercussion of this rate cut. It is going to benefit Indian Industries/Corporates as they would pay lesser interest on their borrowings, increasing their profits! So the Indian stock market should be the place to park some savings in. Imagine the current business climate in India:

• Reduced crude prices
• Reduced interest rates
• Growth-oriented government

Now if this doesn’t push the profits up, no period would!

To clarify,

• Long-Term Investments: This is the perfect time to invest in mutual funds if one has a long-term view (preferably 3+ to 5+ years). This means that you can invest the money that you don’t need in the near future in mutual funds. In this manner, you can take part in the 7% plus GDP forecast for the country through these funds. India is a lone star in the ‘emerging economy’ sky. It is time to reap the benefits of the India Growth story.
• Short Term Approach: Continue to direct funds that are required for immediate use to fixed deposits and recurring deposits. Even though it wouldn’t be sufficiently rewarding, remember you always need some for a rainy day.

Hence this is the time to re-think the proportion of your savings that go into mutual funds. Better late than never!

Dreaming of a new abode?

Now is the time to start thinking of your dream house, preferably in 2016. You can expect more rate cuts as the RBI governor hinted about his happiness with inflation levels. Don’t hurry, but start preparing for a purchase next year. Given that the real estate market is struggling, coupled with a reduced interest rate, it’s probably the best time to get a great price at a reasonable home loan EMI. This is not an investment advice; it’s for a family that wants a house to live in to catch a good opportunity.

The Broad Takeaway

A friend of mine, when asked about the rate cut, told me (in crude Hindi):

“RBI changes repo rate; my world doesn’t change”

This financial ignorance in the aam-aadmi needs to change. Macro changes in the monetary policy percolate through the system and influence every citizen of this country especially their financial health. The decision to cut rates is made based on certain economic metrics, mainly inflation. As the ‘inflation’ comes down, the RBI will try to reduce the repo rate further. Keep track of these changes and modify your investment approach prudently.

If you didn’t care about the macro actions, start caring now! It impacts you! Correct investment strategies set you on a path of financial stability and ultimately freedom.

Arjun Balakrishnan is an investment fanatic who loves writing about investment topics. He regularly writes at Investment Gyaan.