When you go for bank loans, and the interest rate is high, the explanation you will get is that the repo rate is high. So what is repo rate? Repo rate can be defined as the interest rate set by the central bank. It is the interest rate at which banks get loans from the central bank when they have a shortage of funds.
The repo rate is used to control liquidity in the economy. When there is inflation, the central bank increases the repo rate. In this way, loans that are given out by banks become expensive and less money is given out to borrowers. This reduces the amount of money in circulation and controls inflation. When the repo rate is high, banks always transfer the interest to the individuals borrowing loans from them, thus causing the cost of borrowing to spike.
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Effects of a high repo rate
Some effects of a high repo rate are –
Loans become expensive – Repo rate can impact your loan interest rate. With the increase in repo rate, there will be an increase in loan interest rates. This is because banks transfer high-interest rates to the consumers. A high repo rate means loans will be more expensive as their interest rate increases. The same applies to personal loans and home loans.
When repo rates are high, many borrowers cannot afford a loan.
Slow growth of SMEs – SMEs rely on affordable loans from banks to grow their business ventures. With a high repo rate, the interest rates will also increase, and thus borrowers may not be able to afford loans. This affects even those with existing loans, and under such circumstances, financial institutions are likely to experience a high defaulting rate. Hence, due to the increase in interest rates on loans, SMEs find it challenging to expand their business ventures.
Fewer investments – When repo rates increase, there will be less money being injected into the economy, resulting in fewer investments.
High cost of living – Increase in repo rate has a lot of impact on the cost of living. It tends to slow down the economy. With less money circulating and expensive loans, there will be lifestyle changes. Salaried people who have already availed of loans will be forced to pay more monthly instalments, leaving them with less to spend.
Entrepreneurs may also be forced to increase the prices of their products so that they can pay their monthly instalments with high-interest rates.
Increased cost of running a business – Business ventures that rely on loans to run their daily operations will have to pay more due to increased loan interest rates.
Effects of a decrease in repo rate
A decrease in repo rate has effects on different sectors of the economy, which are –
Affordable loans – When there is a decrease in the repo rate, the common man is happy since it means low-cost loans. Financial institutions lower interest rates on loans when the central bank decreases the repo rate. This means that many can access loans, and there is an increase in investments. Borrowers can access all kinds of loans when interest rates are reduced.
Rapid growth of SMEs – Rapid growth of SMEs means an improved economy. With a decrease in repo rate, many small and medium enterprises can access affordable loans from financial institutions. This makes it possible for them to grow their ventures as the burden of paying a high-interest rate on loans has been removed.
Access to more loans – A decrease in the repo rate allows banks to access more funds from the central bank. This means that they have more money to give out in the form of various loans.
Low cost of living – While a high repo rate increases the cost of living, a decreased or low repo rate improves the same. Business entities reduce the cost of products because of low-interest rates. Those who are salaried also have more money to spend because the monthly loan repayment is diminished.
More investments – Investors will be able to invest more as they can access bigger loans with a lower interest rate. With more investments, job opportunities are also created, leading to improved economic conditions.
Th repo rate keeps changing from time to time. It is never constant. Changes depend on the economy as monetary authorities use repo rate to control inflation. When inflation is high, the repo rate increases so that money circulating in the economy reduces. The vice versa happens when inflation is maintained and there is a need for more money in the market. In such an event, the repo rate is reduced to allow banks to access more funds which they can give to their clients in the form of affordable loans.