RBI repo rate cut: How it impacts debt mutual funds, FDs and loans

The Reserve Bank of India (RBI) reduced the repo rate by 25 basis points (bps) to 6.25 per cent today on February 7, 2025. This marks the first rate cut in nearly five years.

The last rate cut occurred in May 2020, when the RBI lowered rates to 4 per cent to support the Covid-hit economy. Later, as growth recovered, a rate hike cycle began in May 2022 until February 2023 when the repo rate reached 6.50 per cent.

Since then, rates remained unchanged as the RBI balanced inflation concerns with growth. However, with an easing inflation and GDP growth slowing to a four-year low, there was growing anticipation of a rate cut—which has now materialised.

We now look at how the rate cut impacts your debt investments, loans, and savings.

Impact on debt mutual funds

Interest rate cuts positively impact debt mutual funds by boosting bond prices. When the RBI reduces rates, older bonds with higher interest rates become more attractive compared to newly issued bonds. This pushes bond prices up, boosting the NAV of the debt fund.

However, the extent of the benefit varies depending on the type of fund you invest in.

• Long-duration funds: These funds invest in bonds with longer maturities and hence benefit more when rates decline, as the bonds held by them offer higher rates for a longer time.
  
• Short-duration funds: These funds invest in bonds with shorter maturities. While they still benefit from a rate cut, the impact is smaller compared to long-duration funds.

While long-duration funds might see short-term gains, they are also vulnerable to larger declines when interest rates rise. Short-duration funds, on the other hand, are more stable and less impacted by interest rate changes. For most investors, short-duration funds remain a better choice since while investing in fixed income, stability should be prioritised over returns.

Impact on home loans

Most home loans in India are linked to the repo rate. Banks typically cut their home loan rates in line with a falling repo rate. Though the transmission happens with some lag.

So, if you have a floating-rate home loan, this rate cut will help you repay your loan faster and reduce your total interest cost. We have broken this down in detail in our other story.

Impact on fixed deposits

While rate cuts benefit borrowers, they hurt savers. Banks tend to reduce FD interest rates following a repo rate cut. So if you rely on fixed deposits for savings, this is a signal to act fast. Banks are likely to lower FD rates soon, so if you are planning to invest in an FD, lock in the current rates before they drop.

That said, short-duration debt funds are usually a better alternative to FDs as they tend to offer higher returns, liquidity and defer the taxation until you redeem the money.

Remember

Interest rates will always fluctuate, and while these changes can have short-term effects on investments, it's crucial not to let them dictate long-term financial planning. Stay focused on your financial goals, choose investments that align with your needs, and avoid making hasty decisions.

Also read: I invested Rs 3 lakh in small-cap funds last year. Big mistake?