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Why home loan EMIs will not fall despite easing of overnight rates

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Home loan consumers, hoping for a respite from high monthly equated monthly installments (EMIs), will be disappointed after lenders said they will not cut their base rates following the Reserve Bank's decision to cut overnight rates on Monday. Base rate is the minimum rate at which banks can lend to customers. Home loans, mostly floating in nature, are tied to the base rate.

SL Bansal, chairman and managing director of Oriental Bank of Commerce told NDTV, "It (the RBI's decision) will lower the cost of funds for banks and banks will be encouraged to give more concessions this festive season for retail loans... but there is no possibility of cutting base rates across the board."

Here's why home loan consumers will continue to sweat under the burden of high EMIs as of now.

What has the RBI done?

The central bank on Monday cut the marginal standing facility (MSF) or overnight rate by 50 basis points to 9 per cent. It had last month cut the MSF rate by 75 basis points. The MSF is an emergency window through which banks borrow from the RBI using their statutory liquidity ratio securities as collateral.

The RBI also said that it will provide additional liquidity to banks through repo windows. The rates for such funds will be auction-based.

Why RBI cut MSF rate:

In a growing economy like India, short term rates should be lesser than long term rates so that investors have an incentive to lock funds for longer term. The RBI's decision to hike MSF rates by 200 basis points in mid-July (to defend the rupee), however, upset India's yield curve. So, short terms rates rose over long term rates, making long term investment less attractive. To retain long term investors, banks were forced to hike deposit rates and as a result most lenders also increased their lending (base) rates. Hence, EMIs on home loans went up in August.

ICICI Bank, India's largest private lender, raised its base rate by 25 basis points (0.25 per cent), while HDFC Bank hiked base rate by 20 basis points. State Bank of India, the country's biggest lender, had raised rates by 10 basis points.

The two cuts in MSFs are aimed at restoring the primacy of long term rates over short term rates in markets. The cut in MSF also indicates that the RBI is becoming more comfortable about the currency and a bit more concerned about domestic liquidity conditions, Leif Eskesen of HSBS Global said in a statement.

So, will home loan EMIs come down now?

Unlikely. Home loan EMIs can come down only when long term rates come down. Long term rates are linked to the repo rate, which is the rate at which lenders borrow from the RBI. The central bank unexpectedly hiked repo rate by 25 basis points in September. Most analysts expect a similar hike in repo rate later this month because the new RBI governor Raghuram Rajan has set his sight on inflation.

"We expect a 25 basis point repo rate hike at this meeting (October 29) as the RBI's nominal anchor appears to be (implicitly) shifting towards CPI (retail) inflation... and CPI inflation looks likely to remain elevated in the near term," Sonal Varma, India economist of global brokerage Nomura said.

So, unless banks get a clear picture on the direction of repo rate (policy rate), the base rate may not go down. Besides, for banks to lower lending rates, they will have to cut deposit rates, which is unlikely unless short term rates and liquidity situation improves substantially

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