To everyone’s surprise, the Reserve Bank of India (RBI) upped the key interest rate by 40 basis points on Wednesday to contain inflation, which has stayed persistently above goal in recent months. The announcement sent equity benchmarks plummeting, with the BSE Sensex dropping more than 1,400 points in intraday trade to settle at 55,669.03. The NSE Nifty, on the other hand, fell 391 points to settle below 16,700. The very next day market did not recover and saw a huge fall in many shares whereas some stocks did well and balanced the fall.
The rise in the repo rate – the rate at which the RBI lends to commercial banks – from a record low of 4% to 4.40 percent is the first since August 2018, as well as the first time the RBI governor-led monetary policy committee (MPC) has held an unscheduled meeting to discuss hiking the rate.
What is the Repo Rate?
When commercial banks borrow from the RBI by selling their securities to the central bank, the RBI charges a repo rate. It is essentially the interest charged by the RBI when banks borrow, similar to the interest charged by commercial banks on a vehicle or home loan.
The link between the stock market and Policy rate:
Interest rates and the stock market have an inversely proportional relationship. When the central bank raises the repo rate, it has an immediate influence on the stock market. This indicates that, as a result of the repo rate hike, corporations are cutting back on expansion spending, resulting in a drop in growth, a negative impact on earnings and future cash flows, and a drop in stock values. If several corporations follow suit, the stock market will inevitably fall.
In a nutshell, higher interest rates lead to increased savings and a reduction in the flow of money into the economy, resulting in a stock market downturn.
Furthermore, the impact of a decrease in the repo rate is not the same across all sectors. Capital-intensive industries, such as capital goods, infrastructure, and others, are especially exposed to these shifts due to large capital or debt on their books. Stocks in sectors such as information technology (IT) and fast-moving consumer goods (FMCG) are typically less affected.