- Date : 01/02/2023
- Read: 3 mins
Explanation of RBI repo rate and its relationships with inflation, reverse repo rate and economic growth
The Reserve Bank of India changes the repo rate in response to changes in the state of the economy. Repo is the portmanteau for repurchase options or agreements. The repo rate is the interest rate at which commercial banks borrow funds from the RBI.
Let us know more about all the interesting aspects of the RBI repo rate.
What is repo rate of RBI?
The RBI governor presides a bi-monthly meeting with the 6 member Monetary Policy Committee. Changes in the repo rate are made by this committee. The change in the repo rate is made after reviewing the liquidity position in the country, and the primary economic indicators.
RBI lends money to commercial banks with the latter furnishing securities and bonds as collateral. At the end of the loan tenure, the bank can repurchase the collateral at a predetermined price. It pays interest on this loan to the RBI at the repo rate.
Repo rate loans are short-term borrowings and the banks receive overnight or term funds from the RBI. If the bank defaults later, RBI can sell off the collateral securities furnished.
Repo rate and inflation
When the inflation rate in the country is high, the RBI typically raises the repo rate. The higher the repo rate, the more expensive it is for commercial banks to borrow money from RBI. Cascading it further, borrowing money becomes dearer for people who borrow it from these commercial banks. High borrowing cost discourages borrowing, which reduces the inflow of money into the economy. Consequently, price rise in the economy gets controlled.
Repo rate and economic growth
Credit is the lifeblood of economic growth. It helps businesses to expand and grow. If the repo rate is low, borrowing becomes cheaper, and more businesses are encouraged to borrow at a low cost. This helps the economy to grow. The impact of a repo rate hike is that it discourages borrowing and as a result, economic growth slows down.
Repo rate vs reverse repo rate
If you are wondering what is reverse repo rate, it is simply the interest rate paid by the RBI while borrowing funds from commercial banks. Commercial banks park their excess money with the RBI and receive the reverse repo rate interest as income. By raising the reverse repo rate, the RBI can suck the money out of the market, thus reducing the money supply and controlling inflation. When RBI reduces the reverse repo rate, commercial banks prefer to lend money to the customers rather than deposit it with the RBI.
A commercial bank needs to borrow money from the RBI if it has a deficiency of cash reserves. Notably, maintaining a minimum reserve balance is a statutory requirement for banks in India. As an investor or market watcher, you must keep an eye on the repo rate and reverse repo rate changes and patterns. It affects your borrowings, investment yields and your portfolio decisions too.