A few days ago, I had blogged about how 'Global Stock Markets' skid on the news of falling crude prices (pre-dominant and most quoted reason), Euro-Dollar parity, and multiple other reasons which were beyond the grasp of the common man.
Today, the Indian Stock markets had their best rally in the last 68 months. So what has changed in the world since I last blogged. Crude price is down another $5, Euro-Dollar parity has worsened, Greece has not exited the Eurozone. In the last few days, the stock markets in US and Europe have been up and down and all over the place.
Today's rally was triggered by a 0.25% reduction in the repo rate (to 7.75%). Does this small reduction in a rate prescribed by RBI's mighty governor have such a mammoth impact? Before I share my views about the event, let's understand "Repo Rate".
Repo Rate is the rate at which the RBI lends money to commercial banks. Similarly, "Reverse Repo Rate" is the rate at which RBI borrows money from commercial banks. These rates act as benchmarks for the borrowing and lending rates in the markets.
Banks use deposits through 'Current Accounts - Savings Accounts' (CASA deposits) from their customers and lend at a higher rate to other customers. The difference between the rate on the deposits and the rate on loans is called the spread or margin.
Here's why this reduction is not important in the short term.
- First, any reduction in repo rate does not percolate through the banking system to consumers immediately. It takes close to two quarters.
- Secondly, banks are quicker to up interest rates than bring down rates.
- Next, when repo rates go down and if the lending rates have to go down, then rates on deposits will also go down. Banks will not compromise on the margins they make.
If costs of homes, cars, etc. are not coming down, does reduction in interest rates on loans 'excite' the customer to take a loan?
If companies are not running at 100% utilization of their factories, etc. as the demand for their goods is not picking up, will they take new loans to build newer capacities?
Interest movement does have an impact on a country's GDP, inflation, etc. but it cannot single handedly drive the change in a direction which the Finance Minister wants. This interest rate reduction is more of the 'political' pressure exerted on the RBI governor.
Good Economics is Rarely Good Politics. But Bad Politics is Surely Bad Economics.
Summary - wait for a correction to buy stocks. In the interim, analyse which business / company you want to bet on for the future.
Today, the Indian Stock markets had their best rally in the last 68 months. So what has changed in the world since I last blogged. Crude price is down another $5, Euro-Dollar parity has worsened, Greece has not exited the Eurozone. In the last few days, the stock markets in US and Europe have been up and down and all over the place.
Today's rally was triggered by a 0.25% reduction in the repo rate (to 7.75%). Does this small reduction in a rate prescribed by RBI's mighty governor have such a mammoth impact? Before I share my views about the event, let's understand "Repo Rate".
Repo Rate is the rate at which the RBI lends money to commercial banks. Similarly, "Reverse Repo Rate" is the rate at which RBI borrows money from commercial banks. These rates act as benchmarks for the borrowing and lending rates in the markets.
Banks use deposits through 'Current Accounts - Savings Accounts' (CASA deposits) from their customers and lend at a higher rate to other customers. The difference between the rate on the deposits and the rate on loans is called the spread or margin.
Here's why this reduction is not important in the short term.
- First, any reduction in repo rate does not percolate through the banking system to consumers immediately. It takes close to two quarters.
- Secondly, banks are quicker to up interest rates than bring down rates.
- Next, when repo rates go down and if the lending rates have to go down, then rates on deposits will also go down. Banks will not compromise on the margins they make.
If costs of homes, cars, etc. are not coming down, does reduction in interest rates on loans 'excite' the customer to take a loan?
If companies are not running at 100% utilization of their factories, etc. as the demand for their goods is not picking up, will they take new loans to build newer capacities?
Interest movement does have an impact on a country's GDP, inflation, etc. but it cannot single handedly drive the change in a direction which the Finance Minister wants. This interest rate reduction is more of the 'political' pressure exerted on the RBI governor.
Good Economics is Rarely Good Politics. But Bad Politics is Surely Bad Economics.
Summary - wait for a correction to buy stocks. In the interim, analyse which business / company you want to bet on for the future.
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