RBI's Expected 25 bps Rate Hike Will Push Up EMI Costs for Borrowers

The Reserve Bank of India was expected to raise its benchmark lending rate by 25 basis points in early February 2023, marking a significant shift in its approach to controlling inflation. This would be the smallest increase in a single policy move since the central bank began its rate-hiking cycle nearly a year earlier, signaling a deliberate slowdown in the pace of monetary tightening even as price pressures remained a concern.

Since May 2022, the RBI had already lifted its policy repo rate by 225 basis points in a series of increasingly aggressive moves. The central bank had raised rates by 50 basis points three times in succession before moderating to a 35 basis point increase in December, bringing the repo rate to 6.25 percent. This cumulative tightening reflected the RBI's determination to anchor inflation expectations as prices surged across the economy. By January 2023, the central bank noted that commercial banks had responded by raising both their lending and deposit rates in tandem with each policy move, a transmission mechanism that had worked largely as intended.

The expected 25 basis point increase would ripple directly into the monthly payments of millions of borrowers. Banks pass on rate increases to customers through higher equated monthly installments on home loans, auto loans, and other credit products. The transmission had been substantial: external benchmark lending rates had climbed 225 basis points from May through December 2022, while the one-year median marginal cost of funds-based lending rate—a key metric banks use to price loans—had risen 107 basis points. The weighted average lending rate on fresh rupee loans had jumped 135 basis points over the same period. For homebuyers already stretched by rising property prices, another increase meant higher monthly obligations at a time when affordability was already tightening.

Yet the RBI's decision to moderate the pace of hikes reflected a changing calculus. Inflation had eased to 5.72 percent in December 2022, marking the second consecutive month below the central bank's upper tolerance limit of 6 percent. Global uncertainties—particularly the slowing pace of U.S. Federal Reserve rate increases—had also shifted the outlook. Vivek Rathi, director of research at Knight Frank India, argued that with inflation cooling and growth concerns mounting, the central bank needed to balance its inflation-fighting mandate against the risk of choking off economic expansion. The cumulative transmission of rate hikes into lending rates had reached roughly 60 percent of the total policy rate increase, suggesting that much of the tightening had already worked through the financial system.

The housing market offered a window into the real-world impact. Knight Frank's affordability index for homebuyers had deteriorated by an average of 1.4 percent during the rate cycle, yet demand had remained resilient. Housing credit growth was outpacing other retail lending categories, rising above 15 percent. Ravi Subramanian, managing director and chief executive of Shriram Housing Finance, noted that strong sentiment in non-metro real estate markets suggested demand could absorb the impact of further rate increases. A moderation in the pace of hikes, he argued, would help sustain momentum in housing sales and prevent a sharper slowdown in an otherwise healthy sector.

Not all observers were certain the RBI would deliver exactly 25 basis points, or that such a move would be sufficient. Rachit Chawla, chief executive of Finway FSC, cautioned that if inflation failed to ease further, the central bank might need to maintain a more aggressive stance. Non-banking financial companies and fintech lenders, which rely on wholesale funding markets, would face pressure to raise their own lending rates, passing costs to consumers. Mahesh Shukla, chief executive and founder of PayMe, acknowledged that rate increases would create near-term disruptions for borrowers and lenders alike, but framed them as necessary medicine to prevent larger financial instability. The domestic economy was showing resilience, he noted, largely because of the RBI's disciplined approach to monetary policy.

The February 2023 policy decision thus represented a pivot point: the RBI was signaling that the most aggressive phase of rate increases had passed, yet it was not declaring victory over inflation. Borrowers would face higher EMIs, but the central bank was betting that a slower pace of increases would allow the economy to adjust without tipping into recession. Whether that balance held would depend on how quickly inflation continued to fall and whether global conditions remained stable enough to support domestic growth.