How the interest rate changes?A six-member monetary policy committee (MPC) has been constituted by the Reserve Bank of India to determine the course of monetary policies in the country. This committee is responsible for fixing the benchmark interest rate in India. The meetings of MPC are held throughout the year (at least 4 times) and it publishes its decisions after every such meeting.
In order to maintain the current mandate of 4% annual inflation rate in the country, the committee may revise the repo rate i.e. the rate at which the RBI lends money to commercial banks in India. When the repo rate is slashed, it results in lowering of interest rates charged by the banks, while, an increase in repo rate translates to a rise in interest rates.
Positive effects of rising interest ratesGradually increasing interest rates can have a positive effect on stock markets. Usually, the interest rates rise when the underlying economy of a country is booming. So, when the economy is expanding, it’s obvious that the companies are making more profits. Higher profits, in turn, typically lead to increase in share prices of the companies.
One industry that specifically benefits from rising interest rates is the banking and finance industry. Banks and financial institutions make more profits by lending money at higher rates of interest. This soars up the stock prices of companies related to banking and financial services.
Negative effects of rising interest ratesHigher interest rates increase the cost of borrowing for companies. This directly reduces their corporate earnings. Further, higher interest rates may prevent the companies from taking more loans for their capital expansion and it becomes harder for them to garner more profits in the absence of adequate working capital. All these factors may trigger stock prices to fall.
Higher interest rates may also lead the investors to refrain from investing in stock markets as more lucrative investment options emerge for them. However, while stocks are volatile in nature, they have a history of providing higher long-term average returns than other investment avenues.
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The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.
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