Whenever RBI reviews Monetary Policy, some financial jargon’s hijack the headlines of all the business newspapers and TV channels. Recently, the top headline on all Business Channels was that RBI cuts CRR by 25 bps i.e. 0.25%. 1 bps equals to 0.01%. As a layman, many people don’t even understand what it means and what will be its impact on home loan borrower. The newspapers and TV channels don’t take the pain to explain the exact impact. A very generic conclusion is that your loan interest rate will come down. It may or may not be true.
What is CRR or Cash Reserve Ratio?
In layman terms, Cash reserve Ratio (CRR) is the amount of funds that the banks have to keep with RBI. It is a direct way for RBI to control the liquidity in the system and indirectly control the interest rates. If RBI decides to increase the CRR or Cash Reserve Ratio, the bank reserves decrease. On the other hand, cut in CRR means banks have more funds to lend thus increase the liquidity in the system. RBI use this method (increase/decrease of CRR rate), to increase/decrease liquidity in the market. In short, Increase in liquidity means excess money to the banks for lending. A cut of 75 bps in CRR roughly infuse 48000 Cr in the system.
Now you must be wondering so what is in it for me if RBI has cut the CRR. As a layman, it is a good news for the potential borrowers who are planning to avail the home loan in near future. As i shared, CRR has an indirect impact on the interest rate. For example, more liquidity in the market means banks are under pressure to deploy/lend these funds. Therefore, the banks will decrease the interest rates to increase the demand. I will it in explain in detail in the next section. In short, potential borrowers will have easy access to loans at lower Interest Rates. On the contrary increase in Demand means High Inflation. It’s a cyclic process.
Let me explain, If banks have more money in treasury then they can’t keep it with them, it is profitable for banks to lend this money immediately. An idle money is a loss making proposition for the bank as the bank has to pay interest on the idle money. The bank is in a business of borrowing and lending. High Liquidity lowers the interest rates as the money supply is high but demand may not be high to match the supply. Once interest rates start cooling off, the demand for Homes, Car etc will increase as people are getting cheaper credit & Loans become affordable. Gradually the demand will start picking up and the Inflation will go up. Neither high nor low inflation is good for any economy. Therefore recent rate cuts are the reaction of RBI towards decreasing/low inflation. Lower inflation means demand is decreasing which impact overall Growth of Economy. In order to increase demand, RBI needs to infuse liquidity in the system thus CRR / REPO rate cut. Hope I have explained it in very simple terms.
Why RBI Cut CRR instead of Repo Rate?
The answer is very simple. The Repo Rate cut has wide implication compared to CRR. Any cut in REPO rate decrease the bond yields and can impact the debt market. On the other hand, CRR cut is an indirect way to control the interest rates. A cut in CRR force the banks with low cost of funds to reduce or cut their margins and pass the benefit to potential borrowers. But unfortunately, banks are not willing to pass the same fully. Because of this reason, RBI introduced MCLR (Marginal Cost of Funds Based Lending Rate). The objective is the faster transmission of rate cuts to borrowers compared to the base rate.
The banks have lowered Home Loan Interest Rates and major impact on interest rates is because of cut in REPO rate by RBI. Analysts are anticipating 25 bps to 50 bps REPO rate cut by RBI in 2017. The RBI has already cut REPO rate by 150 bps in last 2 years. It was anticipated that lower interest rates will bring a fresh lease of life to Real Estate sector which is in a coma for quite some time. It would help in revival of the most aspirational sector for Indians because every Indian has a dream to own a house. He spends his life long savings in realizing this dream. Unfortunately, it didn’t happen. The potential buyers are in a wait and watch mode as i explained in my post, Marketing Survey – A Gimmick to influence your buying decision.
According to experts, be it a CRR cut of REPO rate cut, RBI always act in haste. Inflation is now increasing but RBI cut REPO rate recently without analyzing whether steps taken by RBI are influencing demand or not. Despite introducing MCLR, banks are not willing to pass 100% rate cut benefits to borrowers. When inflation has dropped over last few years RBI was in a hurry to infuse liquidity in the system. Its seems, the only job of RBI is to keep inflation within the comfortable zone. Rather RBI should act as a true central bank and monitor all key monetary parameters for overall growth of economy besides inflation. The RBI has set an internal inflation target of 4% (plus/minus 2%). Therefore, RBI will keep reducing REPO Rate and cut CRR till the inflation is in a comfortable zone i.e. below 6%.
In my opinion, the interest rates have bottomed out. Any further cut in interest rates seems highly unlikely. The inflation may increase due to low base effect. Recently, the readers of this blog reported that banks are forcing home loan borrowers to switch from base rate to MCLR. It might be in anticipation of an increase in inflation and interest rates. Therefore, it will difficult for RBI to cut CRR or Repo rate in future to spur demand.
The low-interest rate alone cannot spur demand. The high property prices are another reason for low demand. Unexpectedly the affordable housing projects have not taken off. On top of it, the potential buyers are in a wait and watch mode. Another important factor is a lack of confidence among buyers whether builder will be able to complete the project on time or not.
In the current market, only the buyers who are planning to buy for self-use are house hunting. The investors have taken a knock on their profits in last few years and are finding ways to exit. The investors who bought in 2012-2013 are in a maximum loss. As i keep highlighting that prices have corrected by up to 40% in certain pockets. The turnaround of this sector will begin but when is a million dollar question.
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