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Effect on Repo Rate by RBI

Sonal Pruthi

| Updated: Jan 08, 2021 | Category: RBI Notification

No Change in Repo Rate: By RBI

Repo Rate is the critical policy of India. It defines the interest rate policy of India. RBI Monetary Policy Committee rate decides the repo rate.

Repo rate means that interest rate which the RBI charges/lends money from its licensed commercial banks. The RBI gives these loans to banks at the repo rates so that they meet their short term funds to meet their regulatory or business requirements.

Significance of Repo Rate

The purpose of Repo rate by the central bank is to signal about its monetary policy to the banks, business houses, governments, and to the general public at large. The policy of repo keeps checks on the two aspects;

a. Keeping the inflation under its control
b. Accelerates the economy growth
c. This policy is reviewed by the government from time to time as a part of their monetary policies.
d. The repo rate infuses the liquidity in the banking system by the central bank.

Components of a repo transaction

The critical components of a repo transaction between RBI[1] and commercial banks are as follows:

  • It is the loan which is given by banks for overnight or one day.
  • In this banks will sell approved government securities which are above the SLR limit.
  • The interest charged by RBI on the advanced loan is called the repo rate.
  • The loan availed by banks are repaid after one day, and the securities submitted as collateral is repurchased.

Repo rate and economy

The basic aim of a repo rate change is to affect the cash flow of money within the economy.

Due to increase in repo rate, the flow of money in the economy decreases, whereas the decrease in repo rate increases the flow of money in the economy.

Current repo rate after Covid

Repo rate in India is 4.00% currently, with effect from 04th Dec 20.

Changes in Repo Rate

Changes in Repo Rate

a. When Repo Rate to be cut/reduced:

  1. When the Central Banks wants to lower down the interest rates in the market
  2. It is important for RBI is that inflation and fiscal deficit are in control and demand-led price surge is unlikely to happen.
  3. The economy is slowing down; RBI aims to accelerate growth by signaling an accommodative monetary policy.
  4. When the external balance of payments situation of the country is seen to be stable by the bank.

b. When Repo Rate is Hiked

  1. According to the new MCLR-Marginal Cost of Lending Rate, it is linked to Repo Rate, in which any rise in repo rate will lead to an increase in the MCLR. This will lead to an increase in the interest rate for borrowers who have taken floating rate home loan, personal loan and business loan
  2. RBI and government will have to control the inflation when the Repo Rate increases, in order to control the demand for credit facilities/ loan, which will fall due to higher interest rate.
  3. This will help in achieving the growth target when the Corporate get cheaper funds for business expansion.

c. When RBI Repo Rate is increased

The RBI raises the repo rate in situations such as:

  1. The aim of central bank is to signal higher interest rates in the market
  2. The RBI sees overheating in the economy and perceives a risk that inflation may surge
  3. Frequently there has been a risk of asset bubbles being created due to excessive capital formation
  4. The RBI wants to reduce speculation in foreign exchange or sees a risk of a disorderly depreciation of Indian currency.

d. When repo rate cut translate into lower interest rates

RBI wants to;

  • After cutting the repo rate, the cost of funding of the bank shall reduce.
  • The banks can advance loans to their customers at a lower cost.
  • Generally, banks use the repo rate as a signal to determine their deposit rates, lending rates and base rates.

What is Reverse Repo Rate?

Example:

Suppose a customer’s deposit their surplus funds with banks and they earn extra benefit on the deposits made.

Similarly the banks, they deposit their excess funds with the RBI. They get a rate at which RBI shall provide with them the interest to Banks for depositing funds; it is called the reverse repo rate.

It can be said that the reverse repo rate is that rate of interest which the RBI pays to banks, for the money borrowed from the banks. Here the RBI is the borrower and bank is the lender.

Features:

  1. A reverse repo rate is lower than a repo rate
  2. It is often used to control cash flow.
  3. The increase in reverse repo rate reduces the cash flow in the financial market, and a decrease rate.
  4. A high reverse repo rate could help banks earn more interest
  5. When RBI reduces reverse repo rate, banks invest their money in other lending loans in the market. This increases cash flow.
  6. It is with the reverse repo rate, which ultimately affects the liquidity of funds in the financial markets.

Reasons -Repo Rate affects the economy of our country

It can be well interpreted that after Pandemic, it is the economies which have been affected the most. Due to the fall in the economic activities, which stopped the cash flow in the country? Repo rate comes in the picture due to one single reason, that repo rate- the influx of money by the central bank to the other banks. When the cycle of cash inflow stops, lending and borrowing will be affected.

  • It is that repo rate is a weapon for the Indian monetary policy, which helps to regularize the country’s money- supply- inflation levels and liquidity, which go hand in hand.
  • Repo rate has a direct influence on the cost of borrowing of the banks
  • This means higher the repo rate, then the cost of borrowing for banks will be higher and vice-versa.

The factors which influence the repo rate and its changing behavior:

a. Increasing Inflation

With the increasing levels of inflation, RBI attempts to lower the flow of money in the economy.

  1. First way is to increase the repo rates, as borrowing is an expensive affair for businesses and industries, and in turn, slows down investment and money supply in the market.
  2. As an effect, it impacts the economy’s growth negatively and ultimately, which helps in controlling and reducing the inflation cost.

b. By increasing the liquidity in the market.

RBI is a body whose role is to influx funds into the system, which then reduces the repo rate. As a result, businesses and industries find it cheaper and easier to borrow money for different investment purposes. Hence, it increases the overall supply of money in the economy. In turn, boosts the growth rate of the economy.

Conclusion

The RBI constantly reviews the repo rate and the reverse repo rate according to changing factors in the economy. The RBI whenever aims to modify the rates will impact the economy.

It is been seen that any difference in the repo rates will directly impact/affects loans such as home loans. Also, a fall in the repo rates is to aim at bringing in growth and improving economic development in the country. Ultimately, the consumers will be borrowing more from banks which in turn stabilizes the inflation. The aim is to regulate the borrowing and lending flow and the chain to continue forever, to reduce the cost and cost of inflation.


Ultimately a fall in the repo rate can help the banks in bringing down their lending rate. This is beneficial for retail loan borrowers.

Read our article:RBI Revised Repo Rate during Covid-19 Pandemic

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Sonal Pruthi

She is B.Com (H), LL.B LLM, Cs (Module 2) And Certification In Cyber Law From ILI Qualified. She has Been A Legal Teacher In The Previous Organization. My Strength Is My Expertise Knowledge In Civil Laws, Corporate Law And Tax Laws. I Have Been Legal Teacher And Legal Trainer In The Past Organization. Her Knowledge About The Subjects Have Expanded Due To Teaching Number Students From Various Universities All Over India.

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