RBI MPC: What should borrowers & depositors do amid rising interest rates?

After a surprise rate hike in May in an off-cycle meeting, the Reserve Bank of India's Monetary Policy Committee on Wednesday unanimously voted to increase the benchmark policy rate by 50 basis points. Thus, the repo rate now stands at 4.90 per cent.  

Consequently, the standing deposit facility rate stands adjusted to 4.65 per cent. The marginal standing facility rate and the bank rate stand adjusted to 5.15 per cent. The Monetary Policy Committee voted unanimously to remain focused on the withdrawal of accommodation in order to ensure inflation remains within range going forward, while supporting growth.

The real GDP growth forecast for FY23 has been retained at 7.2 per cent. GDP growth in Q1 is seen at 16.2 per cent, in Q2 at 6.2 per cent, in Q3 at 4.1 per cent, and Q4 at 4.0 per cent.

Meanwhile, the inflation projection for the year has been increased to 6.7 per cent. Inflation in Q1 is seen at 7.5 per cent, in Q2 at 7.4 per cent, in Q3 at 6.2 per cent, and Q4 at 5.8 per cent.

Furthermore, the MPC noted that inflation is likely to remain above the upper tolerance band of 6 per cent through the first three quarters of FY23.

So, what are its implications for depositors?
Usually, the increase in bank deposit rates is not in sync with the repo rate hike by the RBI. Banks hike their deposit rates by a lesser amount. For example, banks had hiked rates by 20-30 basis points on an average after the 40-basis-point hike in May.  

And, more rate hikes are expected in the near future with inflation continuing to remain high.
BankBazaar.com CEO Adhil Shetty told Business Standard that investors who have a lumpsum amount should deposit it in a fixed deposit of three to six months. He said, once these deposits mature, they could consider locking into FDs of longer tenure, depending on where deposit rates are at that point.  

Sanjay Kumar Singh of Business Standard says locking into a fixed deposit of a longer tenure would be a mistake at this juncture. Invest for a longer tenure of one or two years if after six months FD interest rates have peaked out. Those with larger sums should ladder their investments so that their FDs keep maturing at regular intervals and they can average out the returns on the higher side.
 
There are other options, too.

Akhil Mittal, Senior Fund Manager - Fixed Income, Tata Mutual Fund says capital markets have priced in steep rate hikes. Market has priced in a terminal repo rate of 6.5-7% and debt funds and capital markets giving earnings much higher than bank FDs. Floating-rate fund is suited to this cycle. Debt funds also offer options, good pricing and contained risk.There might also be some near-term volatility.
 
And, how should borrowers position themselves? Most longer-tenure loans, such as home loans, are floating-rate loans. At present, only a small percentage of home loan borrowers are on fixed-rate loans. Even there, the rates would be fixed for a limited tenure of two to three years, after which they are liable to be reset. 

Compared to floating-rate customers, customers opting for fixed-rate loans would be paying around 2 to 3 percentage point higher rate.
Meanwhile, shorter-tenure loans, such as personal loans and auto loans, are likely to be at a fixed rate.

Singh of Business Standard says home loan borrowers feeling the pinch of higher EMIs should try to prepay their loans. He says, look to increase the EMI you pay if your salary has increased so that loan tenure remains constant even in a rising interest rate scenario . Also one should look to prepay at 5% of the principal outstanding for that year. Loan tenure can come down from 20 years to 12 years by prepaying 5% of the principal in a constant interest rate scenario. Also one should keep a close eye on your credit score. Lenders reserve the right to hike rate if your credit score deteriorates
 
Clearly, inflation remains the wild card. It will be closely tracked by the RBI as well as individuals, given its impact on everything from household finances to loan burdens and investment strategies. 

From a macro perspective, it remains to be seen how the RBI’s actions rein in inflation, given that a good part of it is imported.