Central Bank Repo Rate: Whenever a central bank like the Reserve Bank of India (RBI) or the Federal Reserve gives any update regarding interest rates, not only the banking sector but the entire stock market becomes turbulent. As soon as the news of rising rates comes, there is often a decline in the market, whereas when the rates fall, investors start buying and the market rises. This is because interest rates have a direct impact on the earnings of companies, decisions of investors and the value of shares.

How does the effect start?
The rate at which the Central Bank lends money to banks is called repo rate in India. When RBI increases this rate, money becomes expensive for banks. After this, banks increase the interest on home loan, car loan and business loan. Its direct impact falls on both companies and common people.

Also read: Education Loan: Craze for taking loans has increased among young Indians, why is the demand for student loans increasing rapidly?

Companies’ expenses increase
Most companies take loans from banks to expand their business. Suppose an auto company has taken a loan of Rs 1,000 crore. If the interest rate increases from 8% to 9%, the company will have to pay crores of rupees of extra interest every year. Due to this the company’s profit decreases. On the other hand, customers avoid buying a new car due to expensive car loans. This means that on one hand the company has to pay more interest and on the other hand sales also decrease. This is the reason why pressure on share prices increases.

Why does the value of shares decrease?
The stock market runs on future earnings. Investors look at how much profit a company can earn in the coming years. But when interest rates increase, bank FDs and government bonds start getting higher returns. In such a situation, investors start finding safe investments more attractive.

For example, if bank FD is giving only 3% interest, then people invest money in stock market for better returns. But if FD starts getting 7%–8% returns, then many investors withdraw money from risky stocks and go into safe investments.

Also read: TRADE ALERT: India is paying a heavy price for not imposing anti-dumping duty! Shocking revelations came in the report

money starts flowing out of the market
In the era of high interest rates, big investors and fund managers also start withdrawing their money from the stock market and investing it in safe options like bonds and FDs. This reduces liquidity in the market and increases pressure on stock indices.

Which sectors are affected the most?

• Tech and growth companies: A large part of the earnings of tech companies is based on the future. Therefore, their shares come under maximum pressure when interest rates increase.
• Banking Sector: Many times banks benefit in the initial stages. Banks increase interest on loans quickly, but increase interest on deposits slowly. This may improve their margins.