The repo rate and reverse repo rate are tools of a central bank in terms of the efficiency and the economic stability of a country. The central bank of the country i.e. the Reserve Bank of India (RBI) applies these measures to keep pace with the financial sector and perform its national economic obligations. Let us now consider these concepts, their significance and their place in India.
Repo Rate Meaning
The cash reserve ratio, or the repo rate, is the interest rate at which commercial banks obtain the required cash from the central bank in order to cover shortfalls in funds. It is a loan that the bank extends to the government for a limited time, as collateral, the authority is responsible for purchasing these securities at a somewhat higher price later. Such closer pricing is just a result of interest (repo rate) difference
Repo Rate Functioning
Commercial banks approach the central bank with short-term liquidity demands, with the repo rate becoming the price of lending for these banks. The RBI influences the money supply in the economy through the repo rate. When the repo rate is high, banks find borrowing difficult and there are fewer dollars in the market, reducing inflation. Conversely, a low repo rate encourages borrowing, increases liquidity and boosts growth.
Repo Rate Importance
The repo rate is important because:
- Managing Inflation: The central bank changes the repo rate to handle inflation. A higher repo rate makes borrowing expensive while cutting money supply and containing inflation.
- Stimulating Growth: Decreasing the repo rate implies borrowing costs are lower, companies are investing and individuals are investing more often and that fuels growth.
- Impacts Interest Rates: The repo rate impacts interest rates commercial banks charge on loans like mortgages and automobile loans.
What is Reverse Repo Rate?
The reverse repo rate is the interest rate the central bank charges commercial banks for parking their surplus funds along with the central bank. It’s a way where the central bank absorbs extra liquidity from the market.
In periods of higher inflation, the RBI might increase the reverse repo rate to motivate commercial banks to deposit extra money together with the central bank. This action decreases liquidity in the market and limits inflation by restricting public borrowing.
Importance of Reverse Repo Rate
The reverse repo rate matters because:
- Managing Inflation: The central bank adjusts the reverse repo rate to control liquidity, indirectly managing inflation. A higher reverse repo rate attracts more deposits from commercial banks, decreasing money supply.
- Liquidity Regulation: The reverse repo rate absorbs excess cash out of commercial banks and keeps the financial system healthy while stopping excess money supply from fueling inflation.
Current Repo Rate 2024 and1 Current Reverse Repo Rate 2024 in India
Let us see the current repo rate and reverse repo rate in India. As on 2024, the repo rate of India is 6.50% with 3.35% reverse repo rate. The RBI routinely revises these rates to meet economic conditions including inflation containment and growth. The rates remain important in determining how much borrowing individuals and companies charge.
| Feature | Repo Rate | Reverse Repo Rate |
| Definition | Interest rate at which the central bank | Interest rate at which commercial banks lend |
| lends money to commercial banks | excess funds to the central bank | |
| Objective | Inject liquidity into the banking system | Absorb excess liquidity from the banking system |
| Collateral | Government securities pledged by banks | Excess funds deposited with the central bank |
| Effect on Inflation | Increased repo rate reduces inflation by reducing money supply | Increased reverse repo rate reduces inflation by absorbing excess liquidity |
| Impact on Borrowing | Higher repo rate increases borrowing costs for banks, which translates to higher loan interest rates for consumers | Higher reverse repo rate encourages banks to deposit excess funds rather than lend out, affecting the supply of credit |
| Current Rate (May 2024) | 6.50% | 3.35% |
Impact of Repo and Reverse Repo Rates on The Economy
The repo and reverse repo rates drive economic activity by impacting borrowing costs, investment and consumer spending. Their impact includes:
- Managing Inflation: The RBI adjusts the repo and reverse repo rate and thus controls inflation. Higher rates limit spending and borrowing and lower rates lower inflation; lower rates do the opposite.
- Economic Growth: The rates impact investment and spending by impacting borrowing costs. Lower rates boost growth by promoting borrowing; higher rates discourage borrowing and slow economic activity.
- Liquidity Management: The reverse repo rate absorbs excess liquidity, stopping inflation from rising because of excess money supply.
How Repo and Reverse Repo Rates Impact People and Businesses
Mentioned below is how the repo and reverse repo rates in India impact people and businesses:
- Home Loans: Changes in repo rates impact home mortgage interest rates. A hike in the repo rate pushes EMIs higher while a reduction in them affects affordability.
- Business Loans: For businesses, repo rate changes impact how much borrowing is needed for expansion and operation. A higher repo rate might discourage investment choices while a lower rate encourages borrowing.
- Savings & Fixed Deposits: The repo rate indirectly impacts savings accounts and fixed deposits and impacts saver returns.
Repo and Reverse Repo Transactions Process
Repo transactions involve the RBI lending funds to commercial banks against government securities. The transaction has the following steps:
- Collateral Submission: Banks promise government securities as collateral to the RBI.
- Lending and Repurchase Agreements: The RBI lends money to the institution which agrees to buy the securities at a set fee and date.
- Interest Payment: The difference in between the sale & repurchase price of the securities would be the interest depending on the repo rate.
Simpler reverse repo transactions see banks depositing excess funds together with the RBI and earning interest in the reverse repo rate.
Final Thoughts
The repo rate and also the reverse repo rate are monetary tools employed by the RBI to regulate liquidity, economic activity and inflation in India. Changing these rates alone might lead the economy to growth or stability as the RBI determines in the case. Their effect on loan expenses, savings and investment make them economic health factors for companies and people alike.
FAQs
What is repo rate and its importance?
The repo rate will be the cost at which RBI lends dollars to financial institutions. It needs to contain inflation and control the money supply.
What is reverse repo rate and how it impacts banks?
The reverse repo rate is the interest rate paid by commercial banks on surplus funds put into the RBI. It induces banks to deposit additional liquidity with the central bank, impacting cash movement in the economic system.
How will the repo rate impact consumer loans?
A higher repo rate implies higher borrowing costs for banks and that might drive higher interest rates on customer loans for example mortgages and automobile loans.
How does the reverse repo rate impact inflation?
By raising the reverse repo rate, the central bank absorbs extra liquidity from the market and thus manages inflation by decreasing cash readily available for public lending.
Why does RBI change repo and reverse repo rates?
The RBI adjusts these rates to meet macroeconomic objectives including inflation management, development and stabilising the market via cash supply and credit availability.
How frequently does the RBI review such rates?
The RBI’s Monetary Policy Committee (MPC) meets every 2 months to evaluate the repo and reverse repo rates and adjust them as required against the financial backdrop.
How does the repo rate affect inflation?
The rise in the repo rate raises the money supply in the market by making borrowing costlier for banks and lowering inflationary pressures by cutting spending and lending.
