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Basics

The Repo Rate is a tool through which a Central Bank (RBI in this case)
controls the money supply in an economy. If Repo rate is increased, it provides
disincentive to banks to borrow money from RBI, thereby effectively reducing
the money supply in the economy. If decreased, on the other hand, it enables
banks to borrow more money from RBI at reduced rates, effectively increasing
the money supply.

Control of money supply is crucial to deal with Inflation. In case of high


inflation, RBI will increase the Repo Rate to arrest inflation by reducing the
money supply. In case inflation decreases, RBI will lower the interest rates
accordingly to increase the money supply.

Now, when RBI decreases the Repo rate, the interest which Banks have to pay
to RBI reduces. They in turn provide the benefit to consumers by reducing their
interest rates on Loans. However, interest on loans isn't the only thing that is
reduced. Also reduced is the interest rates of Saving Accounts, FDs, RDs, etc.

How are businesses affected by this?

Everyone wants their money to grow. That's why most of the money is kept in
FDs, RDs, invested into stocks, mutual funds, and invested into businesses, etc.,
wherein they can expect some returns. With interest rates being as high as 9-
10% in FDs, RDs, etc., keeping the money in Banks is an attractive option for
consumers, considering that this return is without any risk factor. With interest
rates of banks going down, keeping money there becomes less attractive with
low interest rates.

Therefore, consumers start to look for investments with higher returns


compared to Banks. This is where stock market steps in.
Consumers start investing their money in stock markets, mutual funds,
businesses ideas, start-ups, thereby providing capital to the business market.
Note that I'm not saying they necessarily start their business & start-ups, but
rather, just provide the capital in the form of investment, hoping for good
returns. Although these investments have varied level of risks, the returns are
also substantially higher as compared to safer investment options.

This additional money provides impetus to the business sector, increasing the
money supply, and promoting the manufacturing & service industry. Overall,
this increases the Economic activity of the country, which is a good thing.

Loan Interest Rate:

You've said 'a 25 basis points cut in home loan rate will bring down EMIs by Rs
842 on a Rs 50 lakh loan tenure of 20 years'. I assume what you mean to say is
that it will bring down the EMIs to Rs 842 per month per 1 lakh for 20 yrs for
home loan. In 20 years, you'll only payback a little over 2 lakh for a loan of 50
lakh!! Hence the error:

842 x 12 x 20 = 2,02,080

Although, I think it is still wrong. For EMI to be Rs 842 per month per lakh for
a loan period of 20 years, the interest rate would have to be 8.09%. However,
the current home loan interest rates are 10.15%, which calls for a monthly EMI
of Rs 975. Reducing Repo Rate by 25 basis points will lower the interest rates
to maximum 9.95% if banks are willing to transfer the complete benefit to
consumer.

Ignoring those aspects, your question with relation to reduction on loan interest
rates is, 'is it significant enough'?
Yes, it is very significant. Lower interest rates, even if they may seem
insignificant, drive more borrowing. The interest rate isn't reduced only for
Housing loans, but for all loans, viz., infrastructure, education, businesses, etc.

This borrowed money is not sitting idle but is being used to develop
infrastructure, facilities, educate people, etc. Also, the money above, that is
being pulled out of banks and being invested in other areas, fund various other
businesses, projects, products, services, which raise the economic activity in the
country, thereby increasing GDP of the country.

Increase in GDP will in turn strengthen the currency of the country, further
arresting inflation. This is the driving force for growth. It provides the
conditions suitable for growth of any economy.

Even stock market closed on a high due to this news. So how are they both
related?

Stock Market prices take 2 things into consideration:

1. Actual results

2. Anticipated results

Actual results broadly decide the general price of any share in the stock market.
Anticipated results result in its periodic rise and fall based on the demand &
supply principles.

When RBI reduces/increases the Repo Rate, there is a speculation in the market
about the probable effects. Since, reducing the Repo Rate is good for
businesses, there is a speculation that the market would go up. Accordingly,
there would be more buying of shares in the anticipation that market would go
up at later stage. However, following the demand and supply theory, since the
demand of shares in market increases, their price also increases.

This is the reason why there is a rise in Stock Market Prices.

How Does Fiscal Policy Affect a Company?

Fiscal policy refers to the government's spending and taxation practices and
impacts essentially every individual and business in the nation. Fiscal policy
influences the cost of borrowing, the size of your tax bill, the amount of money
the average consumer can afford to spend and, consequently, your bottom line.
Therefore, fiscal policy and its implications are crucial for any small business to
understand.

Fiscal Responsibility - Just like individuals, governments can be thrifty or


extravagant. How much money a government elects to take in via taxation and
what portion of this income it spends has a direct impact on economic activity.
The government's policy is said to be tight if it spends less than it takes in. This
is usually done to repay debt assumed during previous years. If, however, the
government spends more than it collects in taxes, its fiscal policy is
expansionary. Such a policy can be the result of a deliberate plan to accelerate
economic activity or the government may simply be unable balance its books.

Expansionary Policies - As a general rule, the more the government spends,


the better off the business owner. More government spending means more
government jobs, which translates to more consumer spending. A great deal of
government spending goes through independent contractors for such things as
building roads, bridges and so forth. These contractors and their employees are
also consumers of various goods and services, further adding to demand.
Especially if higher government spending is coupled with lower corporate taxes,
as part of an aggressive expansionary fiscal policy, small businesses will enjoy
greater sales while paying less to the tax authority, resulting in excellent net
profits.
Tight Policies - Tight fiscal policy calls for less spending and more taxes, both
of which hit the bottom line of the small business. To spend less, governments
usually lay off workers or at the very least freeze hiring of new employees.
Contracts are scaled down, while some projects that are not highly critical are
put on hold or cancelled. All of these factors result in less money injected into
the system and less spending by both consumers and corporations. The net
result is less demand for goods and services, and lower sales. If the government
also raises taxes, the effect on small business can be devastating.

Long-Term Effects - While an expansionary policy may be good news over the
short term, carrying on such a policy for too long can backfire. If the
government spends more than it takes in, it must borrow to balance its books.
When government borrowing becomes excessive, interest rates tend to climb.
After all, investors prefer to lend to the government than to corporations, since
the government can, at worst, print money to pay its debt. To entice investors,
small as well as large businesses must offer higher interest rates. The higher
cost of borrowing can reduce investment and hiring by businesses, thereby
reducing economic activity.

Impacts of Monetary Policy


The Federal Reserve Bank, in consultation with congress and the executive
branch, makes monetary policy for the U.S. The Federal Reserve (Fed) is the
nation's central bank, and it has the ability to control how much money
circulates and the costs of borrowing money, known as interest. How the Board
of Governors of the Federal Reserve handle the nation's money supply is known
as monetary policy and its effects on everyday life--including business--are
profound.

Borrowing

The Federal Reserve sets the interest rate at which banks borrow money from
them. When the Fed lowers interest rates, they make it cheaper for banks to
access money, which in turn makes banks more likely to lend to businesses and
consumers. Your business's ability to borrow or establish a line of credit can be
largely affected by how expensive or cheap it is for banks to get money.
Interest Rates

The primary thing the Fed controls is the interest rate for banks to borrow
money. Not surprisingly, banks turnaround and pass the savings or cost on to
their borrowers. When the real interest rate is set low for banks, commercial and
consumer interest rates also tend to run lower, making loans more affordable.

Foreign Exchange

Interest rates and the value of the dollar have a distinct relationship. When the
Federal Reserve makes the cost of borrowing cheaper, more money starts
flowing in the economy. The more dollars that are out there, the less each one is
worth. The dollar value drops. Often, when the Fed drops interest rates, it
intends to lower the dollar's value in order to make U.S. goods more affordable,
and therefore, increase U.S. exports, which can foster growth in business and
jobs.

Inflation

During a time of low interest rates and increased money flowing through the
economy, inflation can occur if economic production and employment do not
increase. Stagnant business, despite increased cash, means that more money is
chasing fewer goods and prices rise. One of the goals of monetary policy is to
prevent excessive inflation while fostering economic growth.