Repo Rate is an interest rate at which commercial banks borrow funds by selling their securities to the RBI, either to maintain liquidity or in the case where some statutory measures have been enacted. It is one of the main instruments that the RBI uses to combat the problem of inflation. It is important to note that Repo Rate affects your loan interest rate, so before applying for a loan, it would be beneficial to know “What is Repo Rate.”
Working of the Repo Rate
Whenever you borrow money from a bank, the transaction is accompanied by the imposition of interest on the principal amount. Interest on credit is also called the cost of credit. Also, during a cash crunch, banks borrow money from RBI, and as a consequence, they are obligated to pay interest to the central bank. This rate of interest is known as the Repo Rate. The agreement is one in which banks deliver securities such as Treasury Bills to the RBI when applying for overnight loans. The agreements would also include a repurchase agreement at a predetermined price which would also be in place. Thus, in this case, the bank receives the cash, and the central bank receives the security.
How repo rates affect the economy
The repo rate can play a crucial role in regulating India’s money supply, inflation, and liquidity levels. As the repo rate rises, the banks will have to pay a greater cost of borrowing and vice versa. RBI implements the repo rate to regulate the supply of money in the economy in situations like the following
The rise in the inflation
When inflation reaches high levels, the RBI takes strong measures to slow down money flow into the economy. The most efficient way to achieve this would be to increase the Repo Rate. For this reason, borrowing is a costly affair for industries and businesses, which slows down investment and money supply in the market. A negative impact of this would be on the growth of the economy, which would further help in controlling and monitoring the inflation rate.
Increasing Liquidity in the Market
When the RBI needs to increased liquidity in the market, the Revised Repo Rate is lowered by a few percentage points. Due to this, businesses and industries are finding it more convenient to borrow money for various purposes, including investing. In addition, more money is available in the economy overall due to this. As a result, the rate of economic growth is also boosted.
What is the Reverse Repo Rate?
The reverse repo rate is designed to absorb liquidity and limit investor borrowing power. There is a major difference between Repo Rate vs Reverse Repo Rate. Suppose there is too much liquidity in the market. In that case, the RBI borrows money from commercial banks at Reverse Repo Rate, and the banks take advantage of this by receiving interest on their holdings with the RBI as a return on their investments.
Current Repo Rate and its Impact on Economy
The RBI changes the repo rate as well as the reverse repo rate according to the changing macroeconomic factors of the Indian economy. It totally depends on the current situation of the Indian economy. Whenever the RBI amends the rates, all sectors of the economy are affected, though in different ways. As a result of the rate hike, some segments have benefited, whereas, on the other hand, others may have suffered losses as well. The RBI recently lowered the Repo rate by 25 basis points, from 5.75% to 5.15%. The RBI also reduced the reverse repo rate from 5.5% to 4.9% to counteract inflation. Repo rate changes can directly affect big-ticket loans like home loans.
Reduced repo rates aim to generate growth in the country and enhance the region’s economic development. By borrowing more from the banks, the general public will be able to stabilize the price level and control inflation. The decrease in the repo rate can eventually cause the banks to lower their lending rates due to the decreased repo rate. This, in turn, can be beneficial for borrowers of retail loans.
To lower the loan EMIs, the lender will have to lower the base lending rate. The guidelines issued by the RBI require banks and financial institutions to pass on the benefit of interest rate cuts to their clients as soon as possible. The difference between Repo Rate vs Reverse Repo Rate is major. There is an important note to make the Repo Rate affects your loan interest rate. Therefore, before applying for a loan, it would be beneficial to understand “What is Repo Rate.”
Read Also : What is reverse repo rate, and is it different from repo rate?
