The Reserve Bank of India RBI has been robotically following the US Federal Reserve in relentlessly hiking interest rates and then pressing the pause button. The US central bank has been setting store by the Keynesian theory of “too much money chasing too few goods results in rampant inflation”. India, however, has its own unique problems. Its inflation, especially on the food front, is mainly due to supply side factors which is why despite the RBI’s obsession with and emphasis on monetary policy as a tool to fight inflation, the results are not to be seen on the ground.
The RBI on August 18 directed banks to allow individual borrowers paying loans through EMIs to opt for fixed interest rate system or extension of loan tenor, a move aimed at preventing loanees from falling into the trap of negative amortisation, in wake of rising interest rate. When you opt for the flexible interest for, say, your home loan, you do so in the hope that you would sooner or later get to savour the upside of downward movement in interest rates. This isn’t a vain hope. After all, why should one tie oneself to a fixed interest rate regime especially when, at the time of sanction of loan, the interest rate was high? At any rate even when the interest rate on home loan was low say 6%, the human tendency is to pray for the rates going further south and enjoy the upside of the decline in interest rates. For, it is difficult for even a seasoned economists to time the interest regime just as it is impossible to time the equity market.
Interest rates have moved northward since May 2022 after the central bank started raising the benchmark lending rate (repo) in a bid to check inflation following the outbreak of the Russia-Ukraine war. As a result of 250 basis points increase in the repo rate, a large number of borrowers faced negative amortisation, wherein the Equated Monthly Instalment (EMI) works out to be less than the interest obligation, resulting in persistent increase of the principal amount. Let us say you took a home loan at 6% floating rate and today you are paying 8.5%. And let us say the EMI on loan of 20-year tenure was Rs 6,000 to and now you are paying an EMI of Rs 7,500 but even this heightened EMI may not be adequate to cover the interest necessitating either hike in EMI or lengthening the loan tenure which may not be possible with the borrowers who are on the verge of retirement.
The RBI now says banks should, by December 31, 2023, put in place a regime whereby the borrower has the option to switch over to fixed rate regime or elongation of tenure of the loan or hike in EMI. It also exhorts banks to do loan appraisal more carefully so that they are not faced with a scenario where negative amortisation is a reality. The RBI is tilting at windmills. Plumping for fixed interest is a no-no. RBI must own up that it has needlessly heated up the interest rates and blames the consequences on banks.
The RBI simultaneously has asked banks to stop penal interest from January1, 2024. It is right. Banks hike the interest rates when it finds borrowers have violated the terms of the loan. To wit, a violator, say the one who is always remiss in paying EMI on time, is penalised with half percent extra interest. RBI says while it is fine to impose a deterrent one-time penalty, it is simply not kosher to hike the interest rate. Default by borrowers should not be a source of revenue or a business model for banks.
S Murlidharan is a freelance columnist and writes on economics, business, legal and taxation issues
