The Repo Rate is the interest rate at which commercial banks borrow money by selling assets to our country’s central bank, the Reserve Bank of India (RBI), in order to maintain liquidity in the event of a fund shortfall or regulatory measures. It is one of the RBI’s primary instruments for keeping inflation under control.
What is Repo Rate?
When you borrow money from a bank, you are charged interest on the principle amount. This is referred to as the cost of credit. Similarly, amid a cash constraint, banks borrow money from the RBI and must pay interest to the Central Bank. This interest rate is known as the repo rate.
Repo is an abbreviation for ‘Repurchasing Option’ or ‘Repurchase Agreement.’ It is an arrangement in which banks provide the RBI with qualified securities such as Treasury Bills in exchange for overnight loans. There will also be an agreement in place to repurchase them at a specified price. As a consequence, the bank receives the cash and the security is received by the central bank.
Effects of Repo Rate on the Economy
The repo rate is a key tool of Indian monetary policy, capable of controlling the country’s money supply, inflation levels, and liquidity. Furthermore, repo levels have a direct influence on the cost of borrowing for banks. The more the repo rate, the greater the cost of borrowing for banks, and vice versa.
- Rise in Inflation
The RBI makes concerted attempts to limit the flow of money in the economy during periods of excessive inflation. One approach to accomplish this is to increase the repo rate. Borrowing becomes more expensive for enterprises and sectors as a result, slowing investment and money supply in the economy. As a result, it has a negative influence on economic growth, which aids in the management of inflation. - Increasing Liquidity in the Market
When the RBI has to inject funds into the system, on the other side, it reduces the repo rate. As a result, borrowing money for various investment goals becomes less expensive for enterprises and industries. It also increases the overall money supply in the economy. This eventually enhances the economy’s growth rate.
- Reverse Repo RateThe reverse repo rate is a device that absorbs market liquidity, limiting investors’ borrowing capacity. When the market is too liquid, the RBI borrows money from banks at the reverse repo rate. Banks gain from it by getting interested in their central bank holdings.When the economy is experiencing significant levels of inflation, the RBI raises the reverse repo rate. It encourages banks to deposit more cash with the RBI in order to receive greater yields on surplus funds. Banks are left with fewer cash to lend and borrow to customers.Credit and Finance of MSMEsThe latest raise in the Reserve Bank of India’s (RBI) repo rate – the rate at which the central bank loans money to commercial banks – by 50 basis points to 5.40 percent would affect borrowing rates for MSMEs, but analysts believe that controlling inflation is a higher priority right now. The RBI raised the repo rate for the third time in a row, following a 40 basis point increase in May and a 50 basis point increase in June, bringing the total increase to 140 basis points in three months to control inflation “amid deteriorating global economic and financial conditions,” according to the central bank’s monetary policy statement.This repo rate hike will lead to higher interest rates and higher borrowing costs for MSMEs, but at this point, it is critical to keep inflationary expectations in check in the economy. Controlling inflationary expectations is critical since inflation is a double-edged sword for MSMEs because it not only raises input costs but also leads to a decrease in demand.
Current Repo Rate and its Impact
The RBI maintains the repo rate and the reverse repo rate in response to changing macroeconomic circumstances. When the RBI changes interest rates, it affects all sectors of the economy, albeit in various ways. Some parts benefit from the rate increase, while others may incur losses. The repo rate was recently reduced by 25 basis points to 5.15% from 5.75%. In the same vein, the reverse repo rate was cut from 5.5% to 4.9%.
Changes in repo rates can have a direct influence on large-ticket loans like as house loans. The reduction in repo rates is intended to spur growth and improve the country’s economic progress. Consumers will borrow more from banks, reducing inflation.
If the repo rate falls, banks may drop their lending rates. This might be advantageous for retail loan applicants. However, in order to minimize loan EMIs, the lender must lower its base lending rate. According to RBI standards, banks/financial institutions must pass on the benefits of interest rate decreases to customers as quickly as practicable.
Final Thoughts
The Repo Rate can have a variety of consequences on the general economy, whether it affects the banking industry, a person (ordinary citizen), or another component of the Indian economy. The repo rate is an important tool in Indian monetary policy. It has the ability to control the country’s money supply, inflation, and liquidity. Furthermore, repo levels are strongly tied to the cost of borrowing for banks. Typically, the central bank raises the repo rate to discourage bank borrowing, so reducing the amount of money in the economy and controlling inflation. Bank lending to micro and small businesses (MSEs) climbed by 23.7 percent in June to Rs 14.29 lakh crore, up from Rs 11.55 lakh crore in June previous year, according to RBI statistics.
