The Repo Rate
The Repo Rate
The use of various tools and techniques in controlling the economy’s money supply is known as monetary policy. The central bank is mainly tasked with this policy and helps to promote economic growth in a sustained fashion. Control of various rates in the market is an essential financial tool. Repo rate is one such tool. In this article, we will check out the repo rate's definition, use, history, and impact.
Table of Contents
- The meaning of the Repo Rate
- The function of the Repo Rate
- The History of the RBI’s Repo Rate
- What happens when the repo rate increases?
- What happens when the repo rate decreases?
- How does the repo rate affect inflation?
- Bank rate vs Repo rate
- Difference between repo rate and reverse repo rate
- Conclusion
- FAQS
- The Meaning of the Repo Rate
Abbreviated as the Repurchasing Agreement, the Repo rate is the interest rate at which any country's apex bank lends money to recognized organizations or banking companies. It is a financial tool that facilitates economic borrowing (Forbes India, 2023). When banks take loans from the central bank, collateral such as treasury bills and government bonds are kept.
Using the repo rate as a financial instrument in an economy has multiple benefits.
1. The repo rate is considered a safe investment since collaterals are provided in the agreement.
2. It also helps maintain liquidity in the market.
3. The repo rate is an essential financial tool in keeping inflation in check.
4. The interest rate of repo rate is generally lower than unsecured loans.
The RBI's repo rate fixation has always been turbulent. Historically, the rate has had many ups and downs. Statistics show the aforementioned rate fell from 8% to 6% from the first month of 2014 to August 2017.
It again increased to 6.5% in August 2018, and from there, it steeply fell to 4% in May 2020. However, since then, it has been on a rapid rise, reaching 6.5% in June 2023. As of February 2024, the rate is still at 6.5%.
Increasing repo rate means an increased interest rate for banks gaining loans from the country’s apex bank. This is then transferred to the consumers by hiking the customer interest rate on loans and other credit instruments. The repo rate is increased in the RBI’s quest to lower inflation pressure and strike a positive economic liquidity balance.
An increased repo rate also poses a problem for businesses. It discourages organizations from borrowing for expansion, leading to a slowed growth trajectory (GK WEB DESK, 2024). Businesses also experience cash flow strains and reduced profitability due to increased repo rates.
As discussed earlier, an increase in the repo rate decreases borrowing power. However, a lower repo rate will lower borrowing costs and reduce customer lending rates. Thus, increased borrowing will be observed in the economy, leading to more cash flowing into the market. However, it is only good up to a certain point, beyond which inflation problems will arise.
A decrease in the repo rate will facilitate the growth of various companies in various sectors. It will also allow the stock market and mutual funds firms to thrive since more money will be invested.
One of the primary uses of the said rate by the highest bank of the country is to keep an eye on inflation levels in the economy. In the case of the country’s rapid growth, wherein commodity prices increase rapidly, the central bank raises the repo rate (Das, 2022). This repels banks from taking huge loans further, trickling down to banks increasing the interest rate on loans. Thus, consumers find it challenging to spend money to curtail commodity prices again.
However, when there is economic stagnation, where the market has become highly sluggish, lowering the repo rate will inject money into the market and revive it. It will again encourage borrowing and spending, leading to a slow yet steady revival.
When the commercial banks borrow money from the apex bank for an extended period, the rate is known as the bank rate. On the contrary, when the funds are provided for a short period using collaterals, the rate is termed the repo rate.
Bank rates generally help regulate the broader money supply, while repo rates help manage liquidity and the money market rate. A bank rate change leads to a delayed response in the market against the repo rate, which causes an immediate change. Both these instruments help keep inflation controlled; while the bank rate has an indirect role, the repo rate has an immediate and direct role.
As discussed earlier, the repo rate is when the highest bank lends funds to banks for a short period. The reverse repo rate is the rate at which banking institutions provide money to the country’s highest bank. Thus, both are antagonistic to each other.
While a repo rate can manage short-term fund shortages, a reverse repo rate can lower market liquidity. The repo rate is generally more than the reverse repo rate.
Conclusion
In conclusion, the repo rate is an essential financial instrument that controls inflation and the money supply in the market. We hope we were able to enlighten you on the various impacts of the repo rate on an economy and also on its use and history.
FAQS
- What is the reverse repo rate?
This is the interest rate at which financial institutions lend funds to the country's central bank, helping reduce liquidity in the market.
- What is the full form of the repo rate?
The complete name of this rate is Repurchase Agreement.
- Why does RBI increase the repo rate?
The apex bank generally increases this rate for controlling the money supply in the market instantaneously, which helps control inflation.
- When will the repo rate decrease?
This rate will decrease when there is less money in the market, and the economy is sluggish.
- How many times does the repo rate change in a year?
The RBI reviews changes in the repo rate generally every two months.
- Who decides the repo rate?
This rate is decided by the country’s apex bank, which is the RBI here.
- Why does RBI increase the repo rate?
When excess cash flow in the economy and inflation tensions rise, the highest bank increases the repo rate.
- How does the repo rate control inflation?
By increasing the repo rate, banks' borrowing power is lowered, and an increased interest loan rate also discourages consumers from taking credit. Thus, the flow of money in the economy is considerably lowered, lowering inflation tensions.