Tale of Interest Rates

Today people are keen to know more about percentages of cash reserve ratio (CRR), Repo & Reverse Repo rates than the prices of essential commodities
Tale of Interest Rates
"Technically speaking, any policy rate cut means a relief to the people. However, in an unchanged rate scenario, the borrowers will continue to enjoy the lowest rate of interest on their loans." [Representational Image] Advantus Media Inc. and QuoteInspector.com [Creative Commons]

The Reserve Bank of India (RBI) in its bi-monthly monetary policy review on April 8 (Friday) kept the key policy rates unchanged. The benchmark repo rate stands unchanged at 4% for the 11th straight time. The move of the RBI to keep the rates unchanged was a surprise as the market experts this time were almost certain about a rate hike.

Technically speaking, any policy rate cut means a relief to the people. However, in an unchanged rate scenario, the borrowers will continue to enjoy the lowest rate of interest on their loans.

Interestingly, RBI’s stand on key interest rates not only keeps experts alive with their predictions and analysis, it has over a period of time attracted common man’s attention. Actually, it is the fast financial intermediation even into unreached areas which has changed the economics of thinking preferences of one and all.

Now people keenly follow every spell of stance of monetary policy whenever the apex bank announces it. People today are keen to know more about percentages of cash reserve ratio (CRR), Repo & Reverse Repo rates than the prices of essential commodities.

Interestingly, the rate of interest (RoI) dominates the financial system and each player in the system remains focussed on the percentage of interest they have to pay or receive. Before deliberating upon certain aspects of the current monetary policy announcements, it would be interesting to understand the origin and concept of the rate of interest (RoI).

Basically, the origin of the banking and financial system is full of tales. Financial contracts are reported to be as old as written language. Economic historians sum up that writing appears to have been invented for the purposes of recording financial deals. Where did the idea of borrowing and lending come from? How did the idea of interest payments evolve?

Even as implementation of the concepts in the financial system have undergone a sea change, the basic architecture of the functions of the banking system is intact even today.

If Deposits and Loans & Advances form the pillars of this financial architecture, it is the Rate of Interest (RoI) which is the life line not only of the banking system but of the whole growth process taking place in the economic cycle. Remove this RoI component from the system, you won’t find depositors. Thus, leaving no scope to lend, which means money won’t multiply.

So, it’s the Rate of Interest that generates flow of money from sector to sector and place to place, ultimately resulting in economic development of societies.

Let me share an interesting piece of information. Loans in the pre-urban societies were made in seed grains, animals and tools to farmers. Since one grain of seed could generate a plant with over 100 new grain seeds, after the harvest farmers could easily repay the grain with “interest” in grain.

Also since just so much seed grain could possibly be used, there were natural limits to this lending activity. When animals were loaned interest was paid by sharing in any new animals born. What was loaned had the power of generation, and interest was a sharing of the result. Interest on tool loans would be paid in the product which the tools had helped to create.

In his Ancient Economic History, for instance, Heichelheim believed that this kind of lending occurred as early as the neolithic age, with early “food-money” and credit being linked by about 5000 BC: “Dates, olives, figs, nuts, or seeds of grain were probably lent out . . . to serfs, poorer farmers, and dependents, to be sown and planted, and naturally an increased portion of the harvest had to be returned in kind.”

In addition to fruits and seeds, “animals could be borrowed too for a fixed time limit, the loan being repaid according to a fixed percentage from the young animals born subsequently.”

Today, basic principles of the Interest component remain the same. However, its implementation methodology has undergone change. At the moment banks and financial institutions have triggered interest rate wars to woo depositors as well as borrowers.

What is the current scenario around interest rates after the RBI kept the key rates unchanged?

After the rate announcement on Friday, the repo rate and reverse rate remain at 4% and 3.35%, respectively. This is the lowest rate April 2001. Repo rate was last reduced to 4% on May 22, 2020.

If the present global turmoil and the market conditions are taken into consideration, the hike in rates would be inevitable. A higher domestic retail inflation in coming days may compel the RBI to hike the policy rates going forward. Notably, the Government Securities (G-Sec) rate of India, which is the benchmark of interest rate in a country, has already risen from 6.46% on January 3, 2022, to 6.84% on March 31, 2022.

Soon after the RBI announced unchanged policy rates on April 8, Deutsche Bank (DB) in its report stated that the repo rate will increase to 5.50% by end of this fiscal. DB is expecting two rate hikes in 2022–adding up to 50 bps–and then a rate hike of up to 75 bps in 2023. The terminal repo rate for FY23, they expect, will be 5.50%.

Remarkably, there are reports which reveal the RBI Governor, Shaktikanta Das has joined the chorus for tightening rates. So, the conditions prevailing owing to the inflation woes strongly suggest a rate hike in the near future.

What is the impact of unchanged rates on common borrowers?

As already stated above, we are in the lowest interest rate regime. In other words, the cost of borrowing is the lowest in the country. Now the RBI maintaining yet another status quo stance means that banks won’t immediately increase interest rates on loans. It is worth mentioning that the RBI has already made the banks link their interest rates to the repo rate for quick transmission of cut in rates.

However, the borrowers have to note that a strong scenario is already there for a hike in rates. So, the existing low interest rate regime may not last long.

How are home loan and car loan borrowers benefitted

With the repo rate remaining unchanged, the existing borrowers will continue to enjoy a low interest rate. They will continue to pay their equated monthly installments (EMIs) at the same interest rate.

Meanwhile, it is also an opportunity for a new home loan borrower to take advantage of the low interest rate regime for some more time.

In the context of car loans, the borrowers, both new and existing, can utilize opportunity to their advantage. Since most of the loans in this segment are loaned at fixed rate of interest, the new borrowers can get the loan at a low rate of interest and will remain fixed during the entire period of repayment schedule, even if there is rate hike.

In other words, taking a car loan at the existing low rate of interest will give you advantage of lower EMI payments throughout the tenure of the loan even when the bank increases its overall interest rate.

Disclaimer: The views and opinions expressed in this article are the personal opinions of the author.

The facts, analysis, assumptions and perspective appearing in the article do not reflect the views of GK

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