Is the interest rate cut good for you & me?

An extra buck in our pocket makes happy noises. And when price tags head south, its good news.
A lot is being talked about the recent rate cut announced by the RBI. Does it mean we save more or does it mean we can spend more, basically will we hear the happy noise? Let’s find out.

interest rate cut

The Reserve Bank of India or the RBI is the big daddy of money lending. RBI lends money to all the banks. The rate at which the RBI lends to the banks is called the ‘repo rate’. Now the very handsome Raguram Rajan has cut this repo rate. Rajan can make anything sound good (given his deep voice) but this particular rate cut sent a happy wave through markets & analysts alike.

When the RBI reduces the rate at which banks can borrow from it, banks pass on some of the benefit to its customers. When this cut is passed on (usually not fully) it can mean two things.

Borrowing from the bank gets cheaper, and therefore loans come cheap.

The bank also cuts the rate on fixed deposits its customers make.

(A lower rate on loans almost always results in a cut in FD interest, given that paying high interest on deposits and charging less interest on loans can signal trouble for the bank. It has to find the balance somewhere).

When customers usually businesses, can borrow at a lower rate, it helps the overall business growth and production. The rate cut is also passed on to home loans. So definitely home loans get cheaper and the interest cost on existing home loans is reduced. At the same time interest is cut on deposits, which means your fixed deposits earn less. In the larger sense, it’s sort of unattractive to park your money in deposits, given there’s more production (by businesses), more home loans it has a spiral effect and leads to more expenditure and less savings. From an economist’s point of view, this is actually a good thing. People can borrow more -> produce more-> spend more and -> save less. This is especially good for the economy where inflation is under control.

And that’s exactly what Rajan said, according to him inflation has been tamed. While a lot of us may feel prices are only headed north; empirically speaking inflation is actually going down. (Inflation indices are based on prices of common goods compared between 2 time periods and not ever since we started earning and things only got expensive!).

Rajan would do just the opposite when there are inflationary conditions. If there’s inflation, higher demand is bound to push prices further and the RBI must make it unattractive to spend more. In such a scenario encouraging savings by raising interest rates makes deposits attractive and therefore people save more and expenditure is discouraged.

It’s worthwhile to mention that rate changes happen due to a variety of reasons, think the mortgage and underwriting bubble that hit US. It’s known that the government has been upset with Rajan keeping interest rates static, they’ve been molly coddling him to give some ‘good news’ to the markets (& the economy). Even though Rajan attributed the cut to inflation numbers, our finance minister has been quick to take credit for it. After all, some rate cuts are also the handiwork of capitalist agenda of governments!

Do check with your bank about your home loan interest outgo it should have gone down. Spend if you must, the whole e-commerce bandwagon has gone bonkers.

Here’s to the noisy extra buck in your pocket!

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