How Big Note Ban Could Impact Your EMIs, Bank FD Rates

The government's decision to abolish Rs 500 and Rs 1,000 notes and replace them with new currency to crack down on black money could impact the economy in the near term, say analysts. But they see significant economic benefits in the long term, including lower interest rates and thus lower EMIs on loans.

The immediate currency crunch will put less cash in the hands of consumers, which could drive down prices of goods, helping push inflation lower. That, coupled with higher revenues for the government, and more deposits at banks could drive the overall interest rate in the financial system lower. 

Notes of denominations of Rs 500 and Rs 1,000 together accounted for about 85 per cent of the total value of banknotes, worth nearly Rs 17 lakh crore, in circulation, according to estimates. 

With people rushing to deposit old notes in banks, fixed deposit rates, which have also fallen sharply since the past two years, are likely to slip further.

"The immediate effect could be a lower than normal currency in circulation, migration towards electronic and online payment channels, more usage of institutional financial channels thus leading to a further controlled inflationary impact which will be positive for the interest rates being cut further," said Manoj Nagpal, CEO of Outlook Asia Capital. 

Now, the RBI is expected to make deeper cuts to the repo rate earlier than anticipated, after it lowered it by a quarter percentage point last month.

"In line with our expectation, we believe a further cut of 100-150 bps in interest rates will be seen in the next 18 months," Mr Nagpal said.

Market expert Ajay Bagga expects RBI to cut interest rate at its next policy review meet scheduled for December 7.  

The demonetisation will lead to a surge in bank deposits. Mr Bagga estimates current and saving accounts deposits in bank to go up by Rs 4 lakh crore to 5 lakh crore at the least.

A surge in deposits, possible RBI rate cuts in the future and a weak lending activity could put downward pressure on bank fixed deposit rates, says Mr Nagpal of Outlook Asia Capital.

And with more liquidity in the banking system, analysts expect banks to quicken the pace of RBI rate cuts to the borrowers. 

Mr Nagpal of Outlook Asia Capital says that conservative investors should lock into fixed deposit rates of higher maturity if they want a recurring monthly/annual income or alternatively move to long term debt mutual funds if they want to take benefit of the waning interest cycle. 

Debt or bond markets benefit from a downward trending interest rate cycle.