RBI Cuts Repo Rate to 5.25% as Inflation Hits Historic Low: Impact on Loans and Savings

The Reserve Bank of India (RBI) announced on Friday, December 5, a reduction in the repo rate by 25 basis points to 5.25%. This decision comes as inflation dropped to historic lows and the rupee continued to experience weakness in the market.

The announcement followed the conclusion of the three-day Monetary Policy Committee (MPC) meeting led by Sanjay Malhotra, which was held from December 3 to 5.

With this latest reduction, the total cuts for the year have reached 125 basis points. The Consumer Price Index (CPI), which measures retail inflation, fell dramatically to 0.25% in October, significantly below the RBI's target range of 2% to 6%. After thoroughly evaluating the evolving macroeconomic conditions and outlook, the MPC voted unanimously to implement this 25 basis point reduction to the policy repo rate, effective immediately.

The repo rate represents the interest rate at which commercial banks borrow funds from the RBI by offering government securities as collateral. When the repo rate is higher, borrowing becomes more expensive for banks, while a lower rate allows them to access funds at reduced costs.

The RBI adjusts the repo rate primarily to maintain economic stability—balancing inflation control with growth support. These adjustments help regulate market liquidity, borrowing expenses, and broader economic activities.

When the RBI cuts the repo rate, the effects are most immediately noticeable through floating-rate loans. Banks can obtain cheaper funds and subsequently reduce their lending rates, resulting in lower EMIs for borrowers and potentially allowing them to clear their loans more rapidly.

Conversely, when the repo rate increases, banks face higher borrowing costs, leading them to raise loan interest rates. This causes EMIs to increase or loan tenures to extend if the EMI amount remains unchanged.

Home loans typically experience the greatest impact from repo rate changes due to their long-term nature and floating-rate structures. Auto and personal loans, while not directly linked, are often revised based on banks' overall funding costs. MSME loans are also significantly affected, as many small businesses rely on floating-rate credit.

Deposit rates are also influenced by repo rate adjustments, though less directly. When the repo rate rises, banks may increase interest rates on fixed deposits (FDs) and recurring deposits (RDs) to attract more savings. When it falls, FD and RD rates typically decrease, encouraging savers to consider market-linked or alternative investment options.