Why Your Equity, Debt and Gold Bets Depend on the RBI More Than Ever

Every time the RBI clears its throat, markets perk up their ears, like they did when the RBI slashed policy repo rate by 50 basis points (bps) last week. Before the day of the announcement, big-ticket investors and institutions spend time working on models and simulations that give them an idea of how the central bank’s actions would impact their portfolios.

While such investors hang on every word in the monetary policy statement, it is with equal rigour that retail investors, too, should take cues from RBI’s moves. Whether you are betting on stocks, eyeing a property purchase or just parking money in humble FDs – the RBI is quietly shaping your returns. But central bank actions such as OMO, CRR, VRR and so on can be daunting. Fret not. Here we strip them off the jargon and simplify them, while also explaining what they mean for your investments.

Repo rate

Policy repo rate or simply repo rate is the rate at which the RBI lends to commercial banks. The RBI uses the repo rate to communicate its monetary policy stance – whether expansionary (a repo cut), contractionary (a repo hike) or status quo (pause in the rate cycle).

Do note that the repo rate (currently 5.5 per cent) is just a signal and the actual borrowing/ depositing takes place through RBI’s liquidity corridor – via the Marginal Standing Facility (MSF) and Standing Deposit Facility (SDF). Banks, if faced with liquidity deficit, can tap the MSF, wherein they can borrow from the RBI at repo rate plus 25 bps (currently 5.75 per cent). If they have excess liquidity, they can deposit the excesses with the RBI via the SDF, earning repo minus 25 bps (currently 5.25 per cent). Thus, MSF and SDF create a 50-bp corridor around the repo rate, ensuring that the call money market rates (explained later) stay close to the benchmark repo rate.

Repo rate influences borrowing and lending rates, economic growth and inflation. When the RBI hikes the repo rate, banks have to pay more interest to borrow from it. To maintain profitability, they pass on this higher cost to borrowers, making loans more expensive. At the same time, since banks earn more on loans, they tend to offer higher interest on deposits, benefiting depositors who indirectly fund these loans.

Conversely, when the RBI cuts the repo rate, banks pay less to borrow and can afford to lower lending rates. This makes loans cheaper for both consumers and businesses. Credit-hungry sectors such as infrastructure, power and real estate borrow more to expand, while consumers are incentivised to spend. This easy access to credit fuels demand and helps boost economic growth. If the RBI raises the repo rate instead, the opposite occurs. Loans become costlier, demand slows and economic growth takes a hit.

How it impacts inflation is thus: Inflation occurs as a result of too much cheap money floating around (liquidity) chasing too few goods (and services). A hike in the repo rate arrests surplus liquidity, bringing prices down.

Now, how does it impact your portfolio? Your debt investments (treasury bills, government and corporate bonds, debt mutual funds, etc.) will be the immediate beneficiaries (or casualties) of repo movements. You see, banks depend on the call money market (market where one bank lends to another) to borrow for their very short-term needs (overnight and up to 14 days) and any change in the repo rate impacts call market rates. A repo hike means higher call market rates and vice-versa. Yields of short-term debt instruments take cues from the call market rates. If rates in the call market fall, most likely your 91-day T-bills also will earn less. Similarly, yields of longer-term instruments (such as G-Secs, corporate bonds) also will fall, as their yields are a function of short-term yield plus a spread for holding the securities longer, known as term premium. The fall in long-term yields may not be proportionate though.

For equities though, it’s quite straightforward. A repo rate cut brings down the cost of equity used to discount future cash flows and can take the value of shares upwards and vice-versa. This is so, provided the rate cut is not happening as a response to a shock to the economy, in which case value of equities will depend more on the impact to economy and less on the cost of equity.

Cash reserve ratio

Cash reserve ratio or CRR determines how much portion of a bank’s deposits it needs to keep as reserves with the RBI. It acts as a protective buffer for the banking system against liquidity risks. This balance that banks keep with the RBI doesn’t earn interest.

In a surprise move, the RBI announced that there will be a 100-bp cut to the CRR over four fortnights starting September 6, making it 3 per cent from the current 4 per cent. As banks are mandated to keep less money with the RBI when this takes effect, this is expected to free up liquidity worth ₹2.5 lakh crore, which banks can put to productive use (advancing loans). This is positive for banks and investors in banks. How so? Because, with this additional liquidity in hand, banks need not hustle for deposits and be aggressive with deposit rates. Thus, this will ease their cost of funds. As a result, banks would charge lower interest rates on loans across tenors.

Short-term yields (duration up to one year) which have cooled from levels seen late 2024 to early 2025, thanks to RBI’s measures to infuse liquidity, would go even lower when the 100-bps CRR cut completes in December 2025.

Open market operations

Open Market Operations (OMOs) are tools used by the RBI to manage liquidity in the banking system by buying or selling G-Secs. When there’s surplus liquidity, the RBI sells G-Secs to banks, effectively pulling money out of the system and tightening liquidity. On the other hand, when there’s a shortage of funds in the system, the RBI buys G-Secs from banks. This pumps money into the system, easing liquidity conditions and increasing the money supply.

As regards your portfolio, your short-term debt instruments’ (duration up to one year) yield will come down as the RBI buys bonds off banks and vice-versa. It is to be noted that the RBI conducts OMOs to address short-term liquidity crunches/ excesses. Thus, there may not be any meaningful impact on longer-duration debt instruments and equities, nevertheless it can influence sentiment around assets as well.

Variable rate repo auctions

Like OMOs, VRR or variable rate repo auctions are one of RBI’s tools to inject short-term liquidity. Whenever the central bank perceives a liquidity crunch in the call market, it calls a VRR auction for an amount it assesses to be adequate to bridge the liquidity gap. Banks can participate and bid for an advance from the RBI at a rate higher than the repo rate.

The RBI will specify the tenor of the advance when it announces the auction – for example, a 14-day VRR auction. This means that the bank borrowing through this window has to repay the RBI after 14 days. The RBI often uses the one-day (overnight) VRR auction and hence quite short-term in nature. This can take yields on short-term debt instruments downward, while longer-term debt securities and equities remain unaffected.

While both VRR and buying G-Secs in an OMO are meant to infuse liquidity, the VRR is used to address very short-term, often transient liquidity deficits, while OMOs, in general, address slightly longer-term deficits.

Variable rate reverse repo auctions

VRRR, or Variable Rate Reverse Repo auctions, are very similar to VRR auctions, except that the RBI uses VRRR to absorb excess liquidity in the system, as opposed to addressing liquidity deficits with VRR auctions. Here, banks can bid for an interest rate which the RBI should pay them for parking excess funds with it. VRRR, too, is a short-term tool and can have an impact on yields of short-term debt securities. Debt securities at the longer end and equities largely remain immune.

Impact on gold

Gold, being a safe haven asset, competes with US treasuries. Consequently, actions by US’ Federal Reserve are more relevant for its price moves rather than actions by the RBI. As a rule of thumb, when US Treasury yields go up, gold gets less attractive and thus its price falls. Gold prices rise when US Treasury yields cool down. However, this historical trend has been broken in recent years with both gold and US treasury yields going up.

Similarly, the link between long-term rates and short-term rates is also usually linear. However, if investors are worried that a central bank is cutting interest rates even when inflation risks persist, while short-term rates decline, the long-term rates can increase due to higher term premium.

Published on June 14, 2025