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Things you should know about RBI’s repo rate

Let us see the meaning of repo rate, reverse repo and bank rate.

The Reserve Bank of India serves as a lender of last resort to commercial banks, offering short-term loans during fund shortages. It also helps to maintain liquidity. The repo rate is the interest rate charged by the central bank when lending short-term funds to commercial banks.

In Repo Rate, Repo stands for Repurchasing option, or you may even say Repurchase Agreement.

But why does the RBI charge interest from commercial banks? Since RBI itself is a bank and needs funds to sustain itself, it charges interest from banks. Moreover, it is an instrument to control money supply in the economy.

But RBI does not provide unsecured loans to commercial banks. Banks need to give RBI some collateral security such as government bonds or treasury bills against such loans.

When inflation is rising above expectations, RBI increases the repo rate. An increase in repo rate makes it expensive for commercial banks to take loans from RBI and forces them to use funds judiciously. This refrains banks from taking loans due to high charges. Further, it reduces the supply of money in the economy by soaking liquidity. Less money supply assists in controlling inflation crises in the economy.

In alternate situations, when the money supply needs to be increased in the economy, the repo rate is reduced by RBI.

Who is responsible for deciding the repo rate?

The decisions regarding repo rate are administered by Monetary Policy Council (MPC), which the RBI governor heads. Depending upon the market situation, the rates are finalised and modified from time to time.

What is the reverse repo rate? How is it different from the repo rate?

Repo rate and reverse repo rate are two tools to control the money supply in an economy. The reverse repo rate is the rate at which RBI borrows or arranges funds from commercial banks to reduce the money supply in the economy.

During inflation, when the supply of money is to be reduced in an economy, reverse repo rates are increased. It means RBI offers attractive interest rates to banks for borrowing money from them. Commercial banks, for high-interest rates, get ready to lend funds to RBI instead of disbursing loans to the public. In this case, the liquidity in the market gets soaked, and the money supply is reduced.

Repo rate vs reverse repo rate

The Repo rate is the rate at which RBI lends funds to commercial banks, while the reverse repo rate is the rate at which RBI borrows funds from commercial banks.
The main focus of the repo rate is to control inflation, while the major objective of the reverse repo rate is to control the money supply in the economy.
The reverse repo rate will always be lower than the repo rate.

Difference between Repo rate vs bank rate

Repo rate and bank rate are rates at which banks borrow from the RBI. However, there is a difference. The repo rate is the rate at which the RBI lends to commercial banks by buying securities, whereas the bank rate is the rate at which commercial banks can borrow money from the RBI without putting up any collateral.

Here are the similarities between repo rate and bank rate:

Fixed and altered by the central bank
Used to monitor cash flow in the economy
Offered by the central bank to commercial banks in times of lending funds

Let us look at their comparison below:

1. Time: The key difference between bank rate and repo rate is the duration of funds. A bank rate is a rate of interest charged by the central bank for long-term financial requirements of banks. However, the Repo rate is charged for short-term funds requirements of banks.

2. Collateral security: Bank rate does not involve any collateral security. Repo rate requires collateral security such as bonds, agreements etc., for lending loans.

3. Purpose: Central bank charges bank rates while offering loans to commercial banks. The central bank sets a Repo rate to repurchase securities sold by commercial banks of the country.

4. Degree: Bank rate is always lower than the repo rate. The Repo rate is always greater than the bank rate.

Impact of a repo rate hike on the country

On May 4, 2022, RBI announced a hike in the repo rate by 40 basis points. This led to an increase in the repo rate from 4% to the current rate of 4.4%.

To control rising inflation in the country, RBI had to take this move. The strategy is expected to control the rate and volume of liquidity in the country.

A hike in repo rate means banks will now have to use their funds sensibly. They will refrain from taking loans from the RBI due to high acquisition costs. In a video speech, the RBI’s governor, Shaktikanta Das, says that a jump in repo rate would drain around 87,000 crores of liquidity out of the banking sector of the economy.

“Inflation must be brought under control for the Indian economy to remain steadfast on its path to sustainable and inclusive development,” Mr Das added.

Final thoughts

The Repo rate is a tool used by the RBI to control inflation in the country. A rise in the repo rate helps control the money supply by soaking liquidity from the economy. While it may protect an economy from high inflation, it does not positively impact all the different sectors in an economy. Hence, volatility in the market has gone up, and it might persist for some time due to changes in the repo rate.

Card tokenization: What it means, and why you should care

With the RBI issuing a final circular making card (CC/DC) tokenization mandatory from January 1, 2022, many are wondering why and how card tokenization is going to help. For starters, tokenisation will alleviate security concerns in online transactions. But, tokenisation may also deter cardholders from making low-value online card payments in near term. Here is a detailed look.

What is card tokenization

Card tokenization is a process of substituting sensitive customer data (such as card number, CVV, etc.) with an algorithmically generated token (encrypted) by a token service provider, which could be the card issuer or payment networks. The token flows through the payment system in a secured way without disclosing the customer details or allowing the payment intermediaries (merchants, payment aggregators) to store customer data. This is mainly to ensure customer data safety/security and curb rising instances of fraud/hacks. Any previously stored data (card-on-file) by merchants/payment gateways will have to be erased.

Tokenization as a security enhancement measure is used in many countries, including North America, Asia and selectively in India also. HDFC Bank, ICICI Bank and SBI Cards already have the card tokenization system in place for online transactions, while few players have device-based tokenization (SBI Cards with Samsung) for contactless NFC payments. Instead of creating/using own token generating engine, using the payment networksâ€™ (Visa/Mastercard) engine will be far more cost-efficient and technologically advanced and will have merchant acceptability.

RBI diktat
With effect from January 1, 2022, no entity in the card transaction / payment chain, other than the card issuers and / or card networks, shall store the actual card data. Any such data stored previously shall be purged, as per RBI.

For transaction tracking and / or reconciliation purposes, entities can store limited data â€“ last four digits of actual card number and card issuerâ€™s name â€“ in compliance with the applicable standards.

Besides, the Reserve Bank of India (RBI) has announced two enhancements to the extant framework on card tokenisation services:

1. The device-based tokenisation framework advised vide circulars of January 2019 and August 2021 has been extended to Card-on-File Tokenisation (CoFT) services as well, and

2. Card issuers have been permitted to offer card tokenisation services as Token Service Providers (TSPs). The tokenisation of card data shall be done with explicit customer consent requiring Additional Factor of Authentication (AFA).

The above enhancements are expected to reinforce the safety and security of card data while continuing the convenience in card transactions, RBI says.

Citing the convenience and comfort factor for users while undertaking card transactions online, many entities involved in the card payment transaction chain store actual card details [also known as Card-on-File (CoF)].

In fact, some merchants force their customers to store card details. Availability of such details with a large number of merchants substantially increases the risk of card data being stolen. In the recent past, there were incidents where card data stored by some merchants have been compromised / leaked. Any leakage of CoF data can have serious repercussions because many jurisdictions do not require an AFA for card transactions. Stolen card data can also be used to perpetrate frauds within India through social engineering techniques.

Reserve Bank had, therefore, stipulated in March 2020 that authorised payment aggregators and the merchants onboarded by them should not store actual card data. This would minimise vulnerable points in the system. On a request from the industry, the deadline was extended to end-December 2021, as a one-time measure. RBI has been in regular consultation with the industry to facilitate the transition.

It may be noted that introduction of CoFT, while improving customer data security, will offer customers the same degree of convenience as now. Contrary to some concerns expressed in certain sections of the media, there would be no requirement to input card details for every transaction under the tokenisation arrangement. The efforts of Reserve Bank to deepen digital payments in India and make such payments safe and efficient shall continue.

Expert views

Based on the interactions conducted, Emkay Global Financial Services is of the view that the card tokenization will be a near-term irritant but long-term positive. It will alleviate security concerns for online transactions, may deter cardholders from making low-value online card payments.

Card tokenization is mainly for online transactions, for which, effective January 1, 2022, customers will have to key-in the card number for the first time (as the stored number will be erased) and complete the transaction via a two-factor authentication. At the back-end, a token would be generated by the merchant with the card issuer/network partner, based on which the transaction will be completed, according to Emkay.

Next time the customer will see the card payment option with the last four digits of the card and the payment will be completed smoothly as used to happen earlier. However, operational details are still not out, including validity, number of tokens per merchant, refreshment rate, etc.

Emkay Global believes that the mandatory tokenization of cards and resultant customer inconvenience in the initial phase may deter cardholders from making low-value online card payments and may push them to other payment modes such as UPI and wallets. However, it would alleviate security concerns in online transactions; thus, it will be a long-term positive for the card industry. That said, card companies will have to engage and educate customers while ensuring a smooth tokenization process to protect their share in the payments business.

As per industry reports, the digital payment/lending space is likely to expand (digital payments to reach USD95tn by FY25E from USD30tn and gross merchandise value of â€˜buy-now-pay-laterâ€™ to reach USD45-50bn from USD3-3.5bn), thereby providing enough space for all the players to grow. However, regulatory (RBI, NPCI & so on) support and oversight will also be required for orderly growth of the payment/lending space. Thus, the participants (for e.g. card companies) will have to be adaptive and innovative to grow and generate/sustain profitability in the long run.

Sovereign Gold Bonds 2021-22 – Series I opens from May 17-21: How to apply

If you detest the idea of holding non-productive physical gold, sovereign gold bonds issued by the government can be a good option if you are willing to hold it for long-term. Government of India has vide its Notification No F.No4.(4)-B (W&M)/2021 dated May 12, 2021 has announced the Sovereign Gold Bond Scheme 2020-21, Series I, II, III, IV, V and VI. Under the scheme there will be a distinct series (starting from Series I) for every tranche. Here are all the key details for Series I.

What is the new tranche

The SGB 2021-22 Series I will open for subscription from May 17 and will close on May 21. The gold bonds will be issued on May 25, 2021.

All sovereign gold bonds are backed by sovereign guarantee.

How to apply

Scheduled Commercial Banks (excluding RRBs, Small Finance Banks and Payment Banks), designated Post Offices (as may be notified), Stock Holding Corporation of India Ltd (SHCIL) and recognized stock exchanges viz., National Stock Exchange of India Limited and Bombay Stock Exchange Ltd. are authorized to receive applications for the bonds either directly or through agents and render all services to the customers.

Subscription for the new series of SGBs can be made in different ways. You will receive an acknowledgement.

Wealthzi can help you make investments in SGBs. Register for an account with Wealthzi.com or connect on [email protected].

Two, you can apply for the SGBs online. Some banks provide online application facilities.

Three, you can buy SGBs in a more hassle-free way by engaging with an online platform or your broker. They will guide you in the process.

Note: Whichever route you take for application, clearly state the grams (in units) of gold, your full name and address and â€˜PAN detailsâ€™ issued by the Income Tax Department.

What is the series price

This SGB tranche has an issue price of Rs 4,727 per gm after a discount of Rs 50 for online investment and digital payment.

For those who buy the sovereign gold bonds offline, the issue price will be Rs 4,777 per gm.

The gold bonds are issued in denominations of one gram of gold and in multiples thereof. Minimum investment in the bond is one gram with a maximum limit of subscription of 4 kg for individuals.

Who can invest

Persons resident are eligible to invest in SGB. Each family member can buy the bonds in his/her own name if they satisfy the eligibility criteria.

Eligible investors include individuals, HUFs, trusts, universities and charitable institutions.

Individual investors with subsequent change in residential status from resident to non-resident may continue to hold SGB till early redemption/maturity.

Joint holding is allowed. In case of joint holding, the gold bond holding limit applies to the first applicant.

The application on behalf of the minor has to be made by his/her guardian.

The bond can be gifted/transferable to a relative/friend/anybody who fulfills the eligibility criteria.

What is the SGB interest rate

These gold bonds bear interest at the rate of 2.50 per cent (fixed rate) per annum on the amount of initial investment.

Interest will be credited semi-annually to the bank account of the investor and the last interest will be payable on maturity along with the principal.

The interest received on these bonds is taxed at your relevant slab rate.

Will you get assured allotment

If the customer meets the eligibility criteria, produces a valid identification document and remits the application money on time, he/she will receive the allotment.

What is maturity amount

On maturity, the Gold Bonds will be redeemed in Indian rupees and the redemption price shall be based on simple average of closing price of gold of 999 purity of previous 3 business days from the date of repayment, published by the India Bullion and Jewelers Association Limited.

Both interest and redemption proceeds will be credited to the bank account furnished by the customer at the time of buying the bond.

The investor will be advised one month before maturity regarding the ensuing maturity of the bond.

On the date of maturity, the maturity proceeds will be credited to the bank account as per the details on record.

In case there are changes in any details, such as, account number, email ids, then the investor must intimate the bank/SHCIL/PO promptly.

How to do premature redemption

Though the tenor of the bond is 8 years, early encashment/redemption of the bond is allowed after fifth year from the date of issue on coupon payment dates. The bond will be tradable on Exchanges, if held in demat form. It can also be transferred to any other eligible investor. Capital gains on SGBs sold in the secondary market are taxed at an individualâ€™s income tax slab rate, if held for 36 months or less, and at 20 per cent with indexation benefit if held for more than 36 months.

In case of premature redemption, investors can approach the concerned bank/SHCIL offices/Post Office/agent thirty days before the coupon payment date. Request for premature redemption can only be entertained if the investor approaches the concerned bank/post office at least one day before the coupon payment date. The proceeds will be credited to the customerâ€™s bank account provided at the time of applying for the bond.

Can these bonds be collateral

Yes, these securities are eligible to be used as collateral for loans from banks, financial Institutions and Non-Banking Financial Companies (NBFC). The Loan to Value ratio will be the same as applicable to ordinary gold loan prescribed by RBI from time to time. Granting loan against SGBs would be subject to decision of the bank/financing agency, and cannot be inferred as a matter of right.

What is the tax on maturity

Interest on the sovereign gold bonds will be taxable as per the provisions of the Income-tax Act, 1961 (43 of 1961).
The capital gains tax arising on redemption of SGB to an individual has been exempted. The indexation benefits will be provided to long terms capital gains arising to any person on transfer of bond.

What are gold bonds risks

There may be a risk of capital loss if the market price of gold declines. However, the investor does not lose in terms of the units of gold which he has paid for.

Buying and selling SGBs in the secondary market may not be easy because of insufficient volumes. Select gold ETFs may be a better option from the liquidity point of view.

Can they be held in demat

Yes, the bonds can be held in demat account.

Rising bond yields: What it means for equity, debt investors

Indian financial markets and global financial markets right now have something in common: rising yields. By the end of third week of February, the average increase in India’s G-Sec yields across 3,5 & 10 years was around 31 basis points since the Union Budget on concerns of the market borrowing plans of the government. Things haven’t improved much. Currently, the 10-year G-Sec yield is now ruling at 6.25 per cent.

On the other hand, US yields have risen too. The 10-year US treasury yield has increased to nearly 1.5 per cent from 0.7 per cent six months ago, creating fear in the minds of investors across the globe. In this context, it is important for investors to understand how to read these changes for debt and equity investments.

Understanding rising yields

Simply put, rising yields on bonds means that bond prices are falling.

India’s G-Sec yields are not softening in a hurry. Research firm AcuitÃ© Ratings & Research expects Indiaâ€™s 10-year sovereign yield to rise to 6.40 per cent by March 2022.

From a classical economics standpoint, the rise in bond yields hikes up the cost of capital for companies. When the cost of capital rises for a company, it can affect earnings and, by extension, its valuations.

One thing is clear. Global and local central banks have kept interest rates low for long. So, the increase in yield is in-line with some normalisation that eventually had to happen.

Whenever the bond yield increases, investors are likely to withdraw from equities and look at bonds, who are offering higher money at lower risk.

Indian context

Yet, it is also true that some investors are panicking too much on account of the rising yields. Rising yields is not necessarily a very bad thing. The global rise in yields does not mean a ‘sell call’ on equities.

In the US, the key premise on which bond yields are rising or rather normalising to pre-Covid levels is that US economic recovery will be faster than earlier envisaged resulting in rising inflation. Is US and Indian economic recovery bad for equities? No!

“In our view, equities as an asset class perform better in an environment of â€˜rising growthâ€™ and â€˜moderate inflationâ€™. For example, despite the rise in Indian bond yields from ~5 per cent to 9 per cent and US yields from 3.5 per cent to 5 per cent from 2003 – 2007 as demand-led inflation picked up, global stock markets including India had their best run as growth kept surprising on the upside,” says ICICI Securities.

However, do keep a close watch on the situation. You can take a negative stance when the environment has rising yields and slowing growth or stagflation. This happened in the 2012-2013 period when India GDP growth dipped to ~5 per cent while yields climbed to 9 per cent, coinciding with the taper tantrum. This is the worst environment for stocks.

How to play debt funds

Enough of explanation for equities, let us look at debt – specifically debt funds. The fundamental characteristic of your debt fundâ€™s return is guided by yields. As yields move up the prices of bonds fall. This fall is sharper in longer duration bonds and slower in lower duration bonds.

But if yields move up, the fall in bond prices will be inevitable. So, when yield moves up, there can be losses in debt funds. When the yield up move is gradual, the fall in returns will be gentle. When the yield jump is sharp, the fall in debt fund returns will be sharp.

Do note that debt funds with longer duration are more sensitive than the ones with shorter duration.
The yield impact on debt funds’ existing investments will be progressively lower as and when the funds start buying bonds with higher coupon rate.

Note: If you would like to know what should be your portfolio strategy in an environment of rising yields, connect with the experts at Wealthzi.

Retail investors can open Gilt accounts with RBI

As part of continuing efforts to increase retail participation in government securities and to improve ease of access, the RBI has decided to move beyond the aggregator model and provide retail investors online access to the government securities market.

Now, the access will be provided in both primary and secondary markets along with the facility to open their gilt securities account (Retail Direct) with the RBI. Details of the facility will be issued separately.

Encouraging retail participation in the Government securities market has been the focus area of the Government of India and the RBI. Accordingly, several initiatives viz. introduction of non-competitive bidding in primary auctions, permitting stock exchanges to act as aggregators/facilitators for retail investors and allowing odd-lot segments in the NDS-OM secondary market, had been taken in the past.

Providing direct access to government securities will provide a new avenue for retail investors and at the same time provide a channel for the government to fund economic growth, according to ICICI Direct Research.

“Providing retail investors a direct option to invest in government securities is a good development from a long term perspective,” says Lakshmi Iyer, CIO â€“ Debt & Head â€“ Products, Kotak Mahindra AMC.

“It may just be the beginning of a viable substitute for small savings schemes at market rates. However, much like sovereign gold bonds, likely pick up pace will be at a slow rate,” opines Mahendra Jajoo, CIO, Fixed Income, Mirae Asset Management India.

Usually, the government securities market is majorly driven by institutional investors like mutual funds, banks, insurance companies. Small investors are also allowed to bid for government securities via their demat accounts. But such access was allowed only to the secondary market in government securities via the Reserve Bank of Indiaâ€™s NDS-OM System. The latest move widens the access to both secondary and primary market segments.
Primary markets are where a security is issued for the first time, while secondary markets are where buying and selling of already issued securities happens.

Here’s Why Markets Are Excited about RBI Report on Private Sector Banks

In its recently released report, the RBIÊ¹s Internal Working Group (IWG) has proposed several recommendations to harmonise the ownership guidelines, regulatory landscape, and corporate microstructure of Indian private banks. The recommendations have clear implications for the banking sector and select banking/NBFC stocks. Let’s find out.

Promoter stake

The IWG has recommended that the cap on promotersâ€™ stake in the long run (15 years) may be raised from the current level of 15% to 26% of paid-up voting equity share capital of the bank. If this gets implemented it would bring criteria for other banks at par with Kotak Mahindra Bank that was given an exception. In fact, this recommendation is a positive move toward being â€˜fair to allâ€™ after allowing Mr. Uday Kotak to maintain up to 26% stake in his bank.

This would be positive for IndusInd Bank as the promoter (Hinduja Group) was looking to increase stake (14.7% currently) but was unable to due to regulation while the bank was also in need of capital. Hence, this move addresses both concerns for IndusInd, says analyst Kajal Gandhi of ICICI Securities.

DCB Bank, whose promoter has already expressed interest in increasing their stake, will stand to benefit from such a policy change, as per HDFC Securities.

New small-finance banks like Equitas and Ujjivan, which otherwise had to go for a significant promoter stake dilution, will be beneficiaries if RBI accepts the IWG recommendations in toto.

Do note that some experts believe that voting rights will still be restricted to 15%, and this may come as a dampener unless clarified.
With regards to the recommendation on on-promoter shareholding cap being raised from 10% to 15%, one can expect large cap, well-run banking stocks to be the frontline beneficiaries.

NBFC to banks?

A key recommendation is that well run large non-banking finance companies (NBFCs), with an asset size of Rs 50,000 crore and above, including those which are owned by a corporate house, may be considered for conversion into banks subject to completion of 10 years of operations and other criteria.

This will allow large NBFCs who are willing to go for banking licence and have the desired criteria. Many believe this would be a positive for companies like Bajaj Finance, M&M Finance, Shriram Transport and L&T Finance who can apply for the banking licence if the opportunity materialises. But, there is another side as well.

“(Bajaj Finance) management had also mentioned that consideration of a banking license was after the company becomes 3x its current size. We believe BAF will continue to be a growth story and management would not transform into a bank at the cost of growth at least over the medium term,” says Jignesh Shial, research analyst, Emkay Global Financial Services.

Also, keep an eye on conglomerates such as AB Capital due to their diversified loan book.

Many of the large industrial houses which already have a payments bank (Airtel Payments Bank, Jio Payments Bank, PayTM Payments Bank, etc) could apply for a Small Finance Bank (SFB) license, thereby disrupting the current SFB incumbents, says Raghav Garg of Nirmal Bang Institutional Equities.

NOFHC structure

Banks licensed before 2013 may move to an NOFHC (Non-Operative Financial Holding Company) structure at their discretion. Once the NOFHC structure attains a tax-neutral status, all banks licensed before 2013 shall move to the NOFHC structure within five years from announcement of tax-neutrality.
According to Gandhi, this implementation may not be so straightforward and immediate as the NOFHC structure to attain tax neutrality would require amendments in the Income Tax Act. However, if implemented, banks like SBI, Kotak Mahindra, etc, would have to move into this structure as they have other businesses like insurance, AMC, securities, etc. Fortunately, there is no immediate impact for SBI, Kotak Mahindra, Axis Bank.

Do note that if banks — currently under NOFHC structure — are allowed to exit such a structure if they do not have other group entities in their fold, then there will be some beneficiaries. If implemented, this will be a positive for Equitas SFB, AU SFB, Ujjivan SFB and Bandhan Bank as they can roll the bank into a single entity and can get away with the so-called holding company discount in markets!
Exiting a holding company structure also removes a key overhang to reduce promoter stake to 40% within five years of the commencement of banking operations in both Equitas and Ujjivan, says Motilal Oswal analyst Nitin Aggarwal.

IDFC Ltd can also benefit if the AMC business is sold off.

Too many banks?

Set against banking background, the IWGâ€™s report indeed builds a strong case for increasing the role and number of private banks to further economic development.

Contrary to the opinion of experts, the IWG has recommended allowing large corporate houses to set up banks. “Despite the RBIÊ¹s fresh attempt at welcoming industrial houses to apply for a banking license, we remain relatively sceptical of this route playing out meaningfully in the nearâ€term,” says HDFC Securities. Take a cue from unsuccessful / withdrawn applications under the 2013 edition.

For large corporate houses looking to enter the space, acquisition may be a more attractive route and a few midâ€tier banks serve as interesting potential targets.

RBI keeps rate unchanged, to boost liquidity

The RBI has kept the repo rate unchanged at 4% while maintaining its accommodative policy stance. The Monetary Policy Committee (MPC) of the RBI voted unanimously in favour of keeping the policy repo rate unchanged for the second consecutive time. The RBI also continued with its accommodative policy stance and mentioned that it would maintain the stance for as long as necessary to revive growth on a durable basis and mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target range going forward.

The central bank expects real GDP to contract by 9.5% in FY21, with risks tilted to the downside.

The highlights of the policy are below:

1. Policy measures – Repo rate kept unchanged at 4%.

2. GDP – Real GDP expected to contract by 9.5% in FY21, with risks tilted to the downside.

3. Inflation – Decided to view the high current inflation as transient owing to supply disruptions caused by the COVID-19 pandemic and focus on reviving growth. Upside risks to inflation may be mitigated by a normal monsoon, arrival of new crops, and the base effect.

4. Stance – RBI continued with its accommodative policy stance. It proposes to maintain the stance as long as necessary to revive growth and mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target range.

5. Other measures
–RBI to conduct on tap Targeted Long Term Repo Operation (TLTRO) with tenors upto 3 years for a total amount upto INR 1 trillion at a floating rate linked to the policy repo rate. The scheme will be available upto March 31, 2021.
–Investments made by banks under this facility will be classified as ‘Held to Maturity’ (HTM) even if such investments exceed the permissible limit of 25%.

6. Outlook
–Lower inflation will provide headroom to the RBI for continuing with the accommodative stance.
–The short to medium segment of the curve is attractive due to relatively lower supply in H2 borrowing and relatively attractive valuation.
–RBI highlighted that while there is space for rate cuts, it would like to use this space more judiciously. The future rate actions to hinge upon relevant incoming data.

Post the announcement, the market turned bullish and yields softened by 7-10 bps across the yield curve. The RBI assured market participants that it will continue to maintain comfortable liquidity conditions and conduct market operations in the form of outright and special OMOs. The size of these auctions has doubled to INR 200 billion which may aid bond market sentiments. Further, the announcement on OMO purchases of SDLs is likely to help alleviate supply pressures. Post this announcement, the SDL yields were down by 12-15bps.

The RBI expects real GDP growth in FY21 to be at – 9.5%, with risks tilted to the downside; For Q2FY21, it expects GDP to grow at -9.8%, for Q3FY21 at – 5.6%, and for Q4FY21 at 0.5%. It expects Q1FY22 real GDP growth at 20.6%. The RBI indicated that increased government spending, good rural demand, and robust outlook for agriculture sector augur well for the economy.

On the inflation outlook, the RBI indicated that while supply-chain disruptions are likely to dissipate, aggregate demand is likely to stay subdued. The MPC has decided to view the high current inflation as transient owing to supply disruptions caused by COVID-19 pandemic and focus on reviving growth. The RBI also mentioned that upside risks to inflation may be mitigated by a normal monsoon, arrival of new crops, and due to base effect. Lower inflation will provide headroom to the RBI for continuing with the accommodative stance.

The RBI is focused on ensuring a non-disruptive borrowing program. Scaling up the size of OMOs, introducing on-tap TLTROs, extending HTM limits for banks, and introducing OMOs in SDLs are all steps that are aimed at alleviating funding pressures across the economy. In absence of a calendar for OMOs, market may expect the RBI to use OMOs tactically, as and when the need arises. The short to medium segment of the curve is attractive due to relatively lower supply in the H2 borrowing and relatively attractive valuation. The RBI highlighted that while there is still space for further rate cuts, it would like to use this space more judiciously. Future rate actions by the RBI to hinge upon relevant incoming data.

Source: Excerpts from a note on RBI policy by Franklin Templeton.

How changes in interest rates affect your portfolio

Consistently, the Reserve Bank of India (RBI) changes the interest rates in the nation utilising its fiscal strategy. This influences various loans and deposits. You realise that loan rates change. Nonetheless, do you realise that your investments get influenced as well? Interest rate dynamics affect your investments too. In the recent years, RBI has been cutting interest rates. s

Why the rate cut

Lower loan costs encourage consumer spending in the economy. This gives the country a lift when it is in the midst of slower economic growth. Lower interest rates mean lower loan rates and this urges enterprises to obtain and put the cash in maintaining their business. When organisations progress well, the economy does well too.

In this way, the RBI utilises the fiscal strategy to keep the economy fit as a fiddle. At the point when the economy is developing and in great condition, RBI takes measures to increase loan costs to keep inflation under control. RBI controls the repo rate, which impacts long term loan fees in the nation. Repo rate is the rate at which RBI lends cash to banks in case of any deficit. By setting the repo rate, the RBI in a roundabout way changes long term interest rates, which boosts spending and in the long run encourages industrial and economic prosperity.

Now, how does this affect your investments?

Stock investors

Interest rate changes do not have any direct impact on your stocks. However, RBI’s actions can have a trickle-down effect. For instance, when RBI increases interest rates, banks increase their loan rates and increased rates for business loans can cause companies to halt expansions and reduce employment. Reduced business spending will lower the value of a company’s stock. The reverse will be true when RBI cuts interest rates.

However, note that there is no guarantee that a rate cut will positively impact stocks or a rate hike will reduce stock prices. For instance, falling interest rates happen during periods of economic slowdown coinciding with a bear market. So, stock prices might fall. The impact of the interest rate changes will depend on the stock you chose to invest in.

Debt investors

There is a direct correlation between interest rates and fixed income investments. For these investors, change in interest rates can have significant portfolio implications. How? Bonds and interest rates have an inverse relationship. When interest rates fall, bond prices will rise. When interest rates rise for an extended period, bond prices will decrease. Why does this happen? Newly issued bonds will have higher yields after interest rates rise, making bonds with low coupon rates worth much lesser.

Change in interest rates can directly impact bond yields. Long-term bonds having maturity ranging from 10 to 30 years will have substantial effects. Short-term bonds are less affected by interest rate changes.

If you have bond holdings in your portfolio, such as bond funds, liquid funds or money market funds, falling rates mean a lower return on your investment. If there is an increase in interest rates, deposit rates and debt fund returns will go up. However, understand that interest rate changes impact you, as an investor, only if you are going to redeem your bond holdings.

Let’s consider an example. You purchased a bond for Rs. 3,000. The RBI increases the interest rate and our bond’s market value drops to Rs. 2,900. So, the loss is Rs. 100. However, this loss is only on paper and if you hold the bond to maturity, you will still receive Rs. 3,000. Understand that most times bond price decreases will be offset by bond price increases at a later date if you stay invested.

Other investments

If you have invested in commodities, their prices will increase when interest rates fall and prices may fall when interest rates rise. For instance, gold prices touched an all-time high in India after RBI cut interest rates. If you have property holdings, an interest rate cut can be beneficial. Real estate prices are directly related to interest rates due to the cost of financing. Real estate becomes more attractive as interest rates fall.

What to do?

As interest rate changes can affect investments in different ways, there is no single action you can take. Knowing how to manage your portfolio can help mitigate any potential negative effects. Assess your portfolio and look at how individual asset classes are likely to be impacted by the interest rates. Based on how your portfolio is structured, you can decide whether you should take any action.

You should analyse each investment. For instance, in case of stock investments, try and analyse the industries that might get impacted by interest rate changes. Cyclical industries such as financial institutions, industrial companies, and energy providers tend to perform better when rates rise. Real estate, utilities, and telecommunication, might perform well when interest rates fall.

If you don’t want to do all this, just build a diversified portfolio made up of quality stocks and bonds. Diversifying can help preserve your overall investment portfolio from the negative effects of changing interest rates in the long run. With a balance of stocks and bonds, your portfolio will be better positioned to maintain stability.

Work with wealth consultants at Wealthzi.com to understand how you can minimise the risks arising from interest rate changes to your portfolio.

RBI Policy Review: Loans Cheaper Without Rate Cut

The Reserve Bank of India (RBI) in its monetary policy meet on 6^th February decided to keep repo rates unchanged at 5.15% as expected. This was because of price pressures remaining elevated. However, the central bank has come up with the range of liquidity tools to fuel the slowing economy. These were a series of measures that included relaxed cash reserve requirements for loans to retail customers and enhanced longer-term liquidity for banks. This is to give a fresh impetus to loan demand and to speed up consumption in the economy. Here are the details you need to know.

Cash Reserve Ratio (CRR)

Banks had to mandatorily set aside 4% of cash for every loan that they provide to retail customers. This included loans for automobiles, housing and loans to micro small and medium enterprise (MSME). In a bid to lower interest rates for these loans and push banks’ credit growth, RBI has relaxed the requirements for banks to maintain this CRR for these loans. The exemption will be for all bank credit to these sectors for a period of six months between January 31 and July 31, 2020. This will lower the funding costs for banks and will incentivize them to lend more.

External benchmark

The RBI had asked banks to link all new floating rate retail loans and floating rate loans to MSMEs to an external benchmark. This was with effect from October 1, 2019. Subsequently, most banks linked their lending rates to RBI’s repo rate. According to RBI, in the October-December 2019 quarter, there was reduction in the weighted average lending rate on fresh loans. While rates for housing loans declined by 18 basis points, there was a 87 bps fall in vehicle loans and 23 bps decline in loans to MSMEs.

So, now the central bank has extended the External benchmark-based lending rates to loans for medium enterprises. RBI has announced that starting April 1, 2020, pricing of bank loans to the medium enterprises will also be linked to an external benchmark. This is meant to further strengthen monetary transmission and reduce the borrowing costs of these enterprises.

Long-term repo

To improve long-term liquidity, RBI has announced long-term repos. Following on the lines of the European Central Bank’s Long-Term Refinancing Operation, the RBI announced a new long-term repo operations (LTRO) facility. RBI will conduct term repos of one-year and three-year tenors of up to Rs. 1 lakh crore at the policy rate. This will enable banks to borrow cheaply from RBI.

RBI has introduced LTRO to ensure that durable liquidity is available to banks at reasonable cost and to further encourage banks to improve credit flows to productive sectors. RBI said that it will conduct LTRO from the fortnight beginning February 15. This will bring down short-term rates and help boost investments in company bonds.

RBI will also withdraw the daily fixed rate repo and four 14-day term repos that it has been conducting every fortnight. RBI said that it will ensure that there is adequate provision of liquidity as needed because of evolving market conditions — unrestricted by quantitative limits— at or around the policy rate.

This might put pressure on banks to improve their liquidity management rather than depending on RBI. There might be volatility in overnight call money markets once RBI implements this.

Commercial real estate

The RBI has allowed a one-year extension on the date of commencement of project loans provided to the commercial real estate sector. This is for projects that have been delayed for reasons beyond the control of promoters. This extension will be allowed without classifying the loan account as a Non-Performing Asset (NPA).

Earlier lenders couldn’t extend further credit to borrowers classified as NPAs since the guidelines said that any fresh lending be also classified as bad loans. Now, lenders can extend credit to these real estate borrowers. This will help them be in line with other project loans in the non-infrastructure space. Since the repayment cycle for these projects starts from the date of commencement, an extension will allow the companies to use any income in completing the project rather than sticking to repayments.

The RBI will review the regulations for housing finance companies too. RBI recently took over their supervision from the National Housing Bank.

Debt restructuring

The RBI has extended the cut-off date for the MSME one-time debt restructuring scheme till December 31, 2020. This was supposed to be till March 31, 2020. This scheme is meant for loans that were in default but “standard” as of January 1, 2019. This extension will help speed up monetary policy transmission and improve credit flow. This will benefit the eligible MSME entities which could not be restructured under the provisions of the circular dated Jan. 1, 2019 and the MSME entities which have become stressed thereafter.

However, the eligible loans that can be restructured under the scheme will now been reduced to only those companies that are GST registered. This was not mentioned in the January 2019 circular.

Here’s what each of these measures will mean:

Measure	Impact
Lower CRR	Cheaper auto, home and MSME loans
Long-term repos	Lower funding costs for banks, better loan rates
Extension of debt restructuring	Relief for eligible MSMEs
Protection for realty projects	Lesser delays in project completion

Look out for lower loan rates from banks in the coming days and keep your eyes on bond yields if you are investing in company bonds.

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Who is responsible for deciding the repo rate?

What is the reverse repo rate? How is it different from the repo rate?

Repo rate vs reverse repo rate

Difference between Repo rate vs bank rate

Impact of a repo rate hike on the country

Final thoughts

Promoter stake

NBFC to banks?

NOFHC structure

Too many banks?

The highlights of the policy are below:

Why the rate cut

Stock investors

Debt investors

Other investments

What to do?

Cash Reserve Ratio (CRR)

External benchmark

Long-term repo

Commercial real estate

Debt restructuring

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