Lower Home Loan EMIs In Sight: Here's Why Raghuram Rajan Cut Repo Rate By 50 BPS

The real estate sector has long been eagerly awaiting a cut in the RBI's repo rate*. Even though many analysts expected the RBI to cut the repo rate, few expected a moderate cut of 25 basis points.  On the monetary policy statement issued today, the Reserve Bank of India (RBI) cut the repo rate by 50 basis points, from 7.25 to 6.75 per cent. The repo rate is now at its lowest level since March 2011. 

Why did Raghuram Rajan cut the repo rate by 50 basis points?

A major reason why the RBI was hesitant to cut the repo rate was that the southwest monsoon is deficient by 14 per cent this year. But, the advance estimates indicate that the food grain production this year would be greater than that of the previous year. Moreover, allied farm activities have shown greater resiliency, and rural demand is low. This gives greater space for the RBI to cut the repo rate because inflation is more in control.

Inflation in commodities except food and fuel have declined much in the past three months. Consumer Price Index (CPI) inflation had fallen to 3.66 per cent in August while the Wholesale Price Index (WPI) inflation declined to -4.95 per cent.

The Federal Reserve had also left the interest rates intact though many expected the Fed to hike the interest rates in September. If the Fed had hiked rates, there would have been pressure on the RBI to raise interest rates too.

Even though banks have been cutting interest rates in 2015 following RBI's repo rate cut this year, the decline in interest rates was modest. The decline in the base lending rates of leading commercial banks have been nearly 30 basis points though the RBI cut the repo rate by 75 basis points this year. The RBI cut the repo rate for the first time in January 2015. This means that banks have not been sufficiently transferring benefits to home buyers, even after 8 months. However, to an extent, commercial banks have passed on the rate cut.

Even though there was a revival of growth in the first half of the financial year 2015-16, this was because of the decline in commodity prices, disinflation, greater government spending and such factors. Otherwise, economic growth is slower than expected. Industrial activity was slow in July, and growth in manufacturing activity has been uneven in April-May. So, Raghuram Rajan thinks that a rate cut is necessary for greater productivity.

Infographic By Sandeep Bhatnagar

But, how will this help home buyers?

Home loan interest rates may decline because banks tend to cut the base rate when the RBI cuts the repo rate. This is especially true of the RBI's rate cut today because in today's monetary policy review, however, the repo rate was cut by 50 basis points. In India, a greater rate cut than 25 basis points is necessary for banks to pass on the benefits to home loan borrowers. Many economists have been urging Rajan to cut interest rates since April 2014 because they were more familiar with how monetary policy transmission works in India.

Ankur Dhawan, PropTiger's Chief Business Officer of Resale Transactions said that it is a positive move for the industry that has been clamouring for low interest rates for a long time. "Impact will not be immediate as banks take time to recalculate their cost of funding and passing benefits to home buyers.", he added.

When home loan interest rates decline, many potential home buyers would be able to afford homes. Moreover, the cost of borrowing for real estate developers would decline moderately too. This is more likely, because the RBI said in the monetary policy statement that it will remove the barriers before commercial banks in passing on the benefits of rate cuts to consumers.

Sunil Mishra, the Chief Business Officer of Primary Business of PropTiger.com said that there are two ways in which this 50bps rate cut will impact home demand. “The first is the tactical and more immediate impact which will come through lower interest rates on Home Loans, and hence, making paying EMIs affordable for a larger segment of buyers. The second impact is the more strategic and one which will have higher long-term impact – this will come through improvement of entire investment climate, improvement of the core economy itself, improvement in overall confidence, and hence more money in hands of individuals and hence, more people going for buying homes.”

As real estate prices have been stagnant for a while by now, this is likely to lead to a much-needed revival of the sector.

*Repo rate is the rate at which the RBI lends to commercial banks.