New borrowers set to get maximum benefit as RBI delivers another rate cut

Since the repo rate has been revised by 115 bps in the last two months, EMIs would fall when banks reset loan rates

With the RBI announcing yet another rate cut to support the economy, both deposit and lending rates are set to reduce. And the benefit will be felt first by new borrowers whose loans are linked to the external benchmark, that is, the repo rate. In times like these, when everyone is looking to reduce costs, a 115- basis point (bp) cut (since March 27) in repo will lead to a sizable reduction in their equated monthly instalments (EMIs).

But fixed-deposit investors will feel the pinch, as the RBI’s rate cut is likely to be passed on to depositors promptly. “Not just FD rates, interest rates on even savings deposits may come down further. Do not leave large sums lying idle in your savings accounts,” says Adhil Shetty, chief executive officer, BankBazaar.
 

Existing FD investors don’t have anything to worry about, since their rates will remain unchanged till the end of their tenure. But new FD rates are likely to fall soon. “Lock your money in at the current rate before banks announce rate cuts,” says Pankaj
Mathpal, founder and managing director, Optima Money Managers. There has been one positive development for FD investors. Says Shetty: “Specialised FD products have been launched offering higher interest rates to targeted customers like senior citizens. More such products could be seen in future. Make the most of them.”

Small savings rates may also be reduced. But some, like Public Provident Fund (PPF, 7.1 per cent annual interest rate, tax-free), Senior Citizens Savings Scheme (7.4 per cent annual interest rate, taxable) and Sukanya Samriddhi Yojana (7.6 per cent annual interest rate, tax-free on maturity) will remain attractive, as will the 7.75 per cent Government of India Bond (Taxable). “Investors who don’t need liquidity may go for them,” says Mathpal.

 

However, since most new loans are tied to the repo rate, the transmission of interest rate changes is likely to be higher and faster than in the MCLR and base rate regimes. Existing repo-rate based customers can expect a 40-bp reduction in their current interest within the next few weeks (see table for how much you stand to save). MCLR customers might have to wait longer to see the impact of the rate cut on their loan rates. For new customers, the effective rate might depend on the spread charged by the bank. “Banks may increase the spread anticipating increased credit risk in the wake of the pandemic,” says Shetty.
 

For debt fund investors, lowering of interest has benefited gilt funds. While these funds do not carry credit risk, they run high interest-rate risk. “The bond market is expected to remain volatile. We are close to the bottom of the rate cut cycle. There is uncertainty regarding how much the RBI can cut rates and support the government borrowing programme. And government borrowing is going to be very high. These factors will keep bond yields volatile,” says Pankaj Pathak, fund manager-fixed income, Quantum Asset Management.

Pathak warns against getting into a long-duration gilt fund. In such funds, the fund manager cannot invest in shorter-duration papers, even if his interest-rate outlook has changed. “Investors will be better off in dynamic bond funds, where the fund manager can at least act in response to a change in his interest-rate outlook,” he says. However, this should only be a limited allocation. The bulk of a retail investor’s money should remain in overnight and liquid funds, or at best in shorter-duration funds.