Inflation goes up, the Reserve Bank of India (RBI) raises policy rates, inflation rises further and the RBI increases its key policy rates again and the cycle continues.
With the prices of oil and commodities cooling off due to slower-than-expected recovery in western countries, everybody was hoping that there will be no more rate hikes. Moreover, the slowdown in growth and the deteriorating IIP numbers were an indication that policy rate hikes are harming than helping.
Just before the latest rate hike, the WPI inflation for August came in at 9.8%, way beyond the comfort level of the RBI. Moreover, the RBI has taken a clear stand that it will do everything possible to tame inflation, even at the cost of a slowing economic growth. In its midterm policy review, the RBI raised its key rates for the 12th time in 18 months.
After the recent hike, the repo rate stands at 8.25% and reverse repo rate at 7.25%. Consumer woes increased further because of a subsequent hike in petrol prices.
EMI with respect to policy rates hike
The hike in policy rates results in an increase in the base rate of the banks based on which the interest rates are determined. Hence, any hike in base rate will result in increased home loan and car loan rates. The policy hikes have a major impact on borrowers as they have to consistently shell out a higher EMI after every increase.
For every 25 bps hike, a borrower has to pay about `16-18 more in EMI for every lakh for loan tenure of 20 years. This means if a borrower has taken a loan of `30 lakh for tenure of 20 years, his or her EMI will go up by `480-Rs 540 for every 25 bps hike. This is assuming the banks raise the floating rate by at least this amount. If banks raise the rate more than 25 bps, the burden will further increase.
In last 18 months, the policy rates have gone up by 325 basis points. This means the outflow on a loan of `30 lakh for tenure of 20 years has gone up by at least `6,240 (480*13). This is a huge increment from a borrowers' perspective. For a borrower earning `12 lakh CTC with a take home of 8 lakh, his or her outflow has increased by approximately 10%.
Impact of the latest hike
Let's discuss the impact of recent hike in the policy rates by 25 bps points. We have to see this hike in conjunction with the hikes in the recent past.
Due to relentless policy rate hikes, borrowers are already stretched. Banks have increased the tenures in most of the cases to maximum possible limit. What this means is that banks either have to increase the EMI or find an innovative way to manage the hike or not pass the cost of the borrowing funds from the RBI to the customer at all. This is as far as existing borrowers are concerned.
For new borrowers, the rates are likely to increase for all kinds of loans. Home loans and car loans will become expensive. To manage the higher EMI, borrowers have to take home loans for longer tenures.
Banks have experienced slowdown in demand for loans and the demand may further go down. We can expect banks to come out with innovative schemes to avoid passing the burden to customers as this will surely deter borrowers further.
What should potential borrowers do?
There is a high possibility of policy rate hikes in future as the RBI has provided a clear indication of what people should expect. Despite slowdown in growth and opposition from industry, the RBI has increased it further and hence we can expect more increases if inflation persists.
Borrowers should stay clear of adding a new liability to their portfolio unless absolutely necessary. Expenses should be controlled. Borrowers must cut down on the avoidable expenses.
Finally, in today's high interest regime, due diligence and research on loans offered by various financial institutions is very important. Borrowers should compare the loan rates, processing fees, and prepayment clauses of different banks to zero in on the best deal offered.
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