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Picture this. You are an Indian with a dream of taking an international vacation. Since your credit score is quite good, you decide to avail a personal loan to fund your trip. You choose a banking partner and apply for the loan online. Then, the funds are disbursed to you at an interest rate of 12% per annum.
You assume that simple factors like your income, your credit score and your relationship with the lender affect this interest right. And you’re partly right. They do.
But apart from these aspects, there are also several other factors that impact Indian borrowers. And among these are the changes to the US Fed rates.
What is the US Fed rate?
To understand what the US Fed rate is, we need to first discuss the Federal Reserve - or the Fed, as it is more popularly known. The Federal Reserve is the central banking system in the United States of America. It oversees the functioning of the 12 Federal Reserve Banks in the country.
In regular economic times, when there is no recession or economic crisis, all banks are required to maintain a minimum balance in their accounts with the Fed. This is quite like how you may need to maintain a minimum balance in your bank account.
Now, some US banks may have balances significantly higher than the minimum requirement, while others may have less funds than they need to maintain. So, the banks with inadequate funds borrow money from the banks with extra funds - and promise to pay it back overnight. This borrowing, of course, comes with an interest rate.
And it is this interest rate that is known as the Federal funds rate or the US Fed rate. It is the average rate at which US banks borrow money overnight in the federal funds market.
The impact of Fed rate hikes on India
The Federal Open Markets Committee (FOMC) controls the Fed funds rate. Owing to economic developments, the FOMC may hike the Fed rate by a certain number of points. The most recent Fed rate hike occurred in March 2022, when the US central bank notified that the benchmark rate was to be increased by 0.25 percentage points.
This is the first hike in the Fed rates since 2018. A rise in the Fed rates encourages foreign investors to pull out of the Indian stock markets. This is because they will wish to divert their funds back to the US, seeking safer and more secure returns on their investment.
Following the recent hike in the Fed rate, this phenomenon has already come into effect. As of March 25, 2022, Foreign Portfolio Investors (FPIs) have already sold over Rs. 48,000 crore worth of their investments in Indian markets.
How does the hike in the Fed rate affect borrowers in India?
A hike in the Fed rates will cause foreign investors to pull out of the market. But the Reserve Bank of India, in a bid to stop the outflow of capital, may also decide to hike the repo rates in India in the coming months.
The repo rate is simply the rate at which the RBI lends money to commercial banks in the country. In other words, it is the rate at which Indian banks borrow money from the RBI.
Now, if the RBI decides to increase the repo rates, then the interest rates that banks charge on loans could also rise. The long and short of it is that borrowing funds can become more expensive if this line of events occurs.
That said, Indian borrowers have no reason to worry at present, because the RBI continues to take an accommodative stance. Repo rates have not been hiked, and so, the interest rates on loans in India continue to remain on the affordable end, as per the current low interest regime of the RBI.
The Fed has indicated that there may be plans for further rate hikes in the months ahead. It remains to be seen how the RBI will react to these developments. Our central bank’s next monetary policy review is scheduled between April 6 and April 8. That’s when we’ll get more clarity on how - and if - the RBI will change India’s repo rate.
In the meantime, here’s what it means for you as a borrower. If your loan has a floating rate of interest, it means that the rate will be benchmarked against an external factor, like the repo rate. So, as long as the repo rate remains low, you will continue to enjoy more affordable loans.
On the other hand, if your existing loan is not benchmarked to the repo rate, you can check with your lender if it is possible to switch to a loan that is linked to the repo rate. That way, you can enjoy the benefits of lower interest rates if the RBI keeps the repo rates unchanged.
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