Impact on investors
The Reserve Bank of India’s (or RBI) decision to reduce the repo rate should signal banks to reduce their respective base rates. The base rate is the rate below which a bank cannot lend, and its includes all lending rates that are common across all kinds of borrowers. This system has been in place since July 1, 2010.
The United Bank of India actually did reduce its base rate hours after this rate action by the RBI. In the chart below, the first three banks are public-sector banks, while the remaining four are private-sector banks.
Base rate reduction
A reduction in the base rate makes loans cheaper for consumers. At the same time, it reduces the incentive for people to save, as fixed-deposit rates should drop as well. With fewer reasons to save and more reasons to spend, we expect consumer spending to grow. This should positively impact the gross domestic product (or GDP) of India. Putting India’s economy back on a high-growth path is one of the key aims of the India’s present government.
As with retail investors, cheap loans should encourage corporates to take advantage of cheaper money and invest in their businesses. Cheap loans lower the cost of capital for companies, which lowers the cost of their products. Given that the rupee does not appreciate against the dollar drastically, it should help Indian exporters’ goods become more competitive in the international market.
Higher exports and more profits will likely help these companies’ stocks and ETFs (EPI) (PIN) (INDA), also resulting in increased corporate tax revenue for the Indian government. Higher tax revenues should further ease pressure on the fiscal deficit.
Cheap availability of credit may also work wonders for India’s investment-starved infrastructure sector. Although this is not the only problem the sector is facing, higher investment should help ease infrastructure investment needs. You can read more about this in India’s infrastructure investment requirement.
In the next article, we will take a detailed look at the RBI governor’s statement.