Repo Rate is the rate at which the Reserve Bank of India (RBI) lends money to commercial banks or financial institutions in India against government securities. The current Repo Rate in 2023 is 6.50%. If the RBI lowers the Repo Rate, it increases the money supply in the market, which can help the economy grow. However, if the rate is high, it can slow down economic growth. This article explains what Repo Rate is, how it works, and how it affects the economy in India today.
What is the Meaning of Repo Rate?
The term Repo Rate refers to the interest rate at which a central bank, such as the Reserve Bank of India (RBI), lends money to commercial banks or financial institutions in exchange for government securities. The term ‘Repo’ stands for ‘Repurchase Option,’ and the interest rate charged by the central bank is known as the Repo Rate.
Changes in Repo Rate affect the economy as they can influence the flow of money in the market. When the central bank lowers the Repo Rate, it can lead to an expansion of the economy by increasing the money supply. Conversely, when the central bank raises the Repo Rate, it can restrict economic growth by reducing the money supply.
Importance of RBI Repo Rate
The Repo Rate is an important tool used in the Reserve Bank of India’s (RBI) Monetary Policy. The RBI Governor leads a group called the Monetary Policy Committee (MPC), which typically includes six members. They work together to create, manage, and adjust policy rates based on the country’s liquidity situation. The RBI adjusts policy rates depending on whether there is a shortage or surplus of funds in the country. When banks borrow money from the RBI using Repo Rate, there are certain aspects to the transaction that takes place between them.
- The RBI lends money to banks through a legal agreement that requires collateral, which can be securities and bonds.
- The RBI uses securities from banks to lend monetary help, and hedges and leverages against them.
- Repo Rate loans or transactions are short-term borrowings, with banks getting overnight or term funds while the RBI holds the securities.
- Banks can repurchase securities on a specified date and at a predetermined price, with the interest amount calculated on the loan amount.
- If banks fail to repay the cash on a predetermined date, the RBI is authorized to sell these securities.
- Banks may borrow money to deal with a deficiency of cash reserves or to maintain the minimum reserve balance as a statutory measure
Current Repo Rate in India
The Monetary Policy Committee (MPC) increased the repo rate by 0.25% to 6.50% on February 8th, 2023. This followed a previous increase on December 7th, 2022 when it was set at 6.25%. The MPC decided to keep the reverse repo rate at 3.35%. Additionally, the Bank and marginal standing facility rates were adjusted to 5.15% and 6.75%, respectively.
Repo Rate Timeline in India: 2015-2023
| Effective Date | Repo Rate (%) |
|---|---|
| 08-June-2023 | 6.50%* |
| 08-Feb-2023 | 6.50%* |
| 07-Dec-2022 | 6.25% |
| 30-Sep-2022 | 5.90% |
| 08-Jun-2022 | 4.90% |
| 13-May-2022 | 4.40% |
| 04-Dec-2020 | 4.00% |
| 09-Oct-2020 | 4.00% |
| 06-Aug-2020 | 4.00% |
| 22-May-2020 | 4.00% |
| 27-Mar-2020 | 4.40% |
| 06-Feb-2020 | 5.15% |
| 05-Dec-2019 | 5.15% |
| 10-Oct-2019 | 5.15% |
| 07-Aug-2019 | 5.40% |
| 06-June-2019 | 5.75% |
| 04-Apr-2019 | 6.00% |
| 07-Feb-2019 | 6.25% |
| 01-Aug-2018 | 6.50% |
| 06-June-2018 | 6.25% |
| 02-Aug-2017 | 6.00% |
| 04-Oct-2016 | 6.25% |
| 05-Apr-2016 | 6.50% |
| 29-Sept-2015 | 6.75% |
| 02-June-2015 | 7.25% |
| 04-Mar-2015 | 7.50% |
| 15-Jan-2015 | 7.75% |
How Does Repo Rate Function?
Banks can borrow money from the RBI by pledging securities and repurchasing them the following day. This is a short-term loan option, typically for just one day, and is meant to help banks face a cash crunch. However, sometimes banks may need this loan for more than one day. In such cases, it is called a Term Repo or Variable Rate Term Repo, and the RBI typically announces an auction for it. The term can range from 7 to 28 days.
The Overnight Repo rate and the Term Repo rate are influenced by inflation rates. When the inflation rate is higher than what the RBI considers acceptable, it may increase the Repo Rate to help control it. Increasing the Repo Rate can also help infuse liquidity in the market with a lower cost of funds for borrowers.
Impact of Repo Rate Change
Changing the interest rates, even by a small amount, can have a big effect. The interest rates affect how easy it is to get loans, how much money is available, how much things cost, and how well the economy is doing. When the interest rates change, it can help or hurt the economy. Sometimes the interest rates need to be raised or lowered to keep prices from going up too fast. Here’s what happens when the interest rates go up or down:
- Impact on Inflation & Economy
When the interest rate is high, banks tend to avoid borrowing to prevent paying high-interest rates. They also become cautious about lending out money, which can hinder money flow and economic activity. However, a high-interest rate can also help prevent inflation from increasing too quickly.
On the other hand, when the central bank reduces the interest rate, it makes borrowing easier for banks, encouraging them to invest and spend more money. This increase in cash flow can result in a faster business cycle and a potential economic boom. Banks can lend more money, which can be used for investment purposes, ultimately leading to economic growth.
- Impact on Bank Loan Rates
When interest rates are high, banks have to pay more interest on the loans they take from the central bank. To make up for this, they may charge higher interest rates to their customers, making it more difficult for people to borrow money. The central bank tries to discourage borrowing, and banks in turn discourage their customers from taking out loans. This helps to reduce the amount of money available in the market, which can help control inflation.
As interest rates decline, banks may lower their interest rates to attract more customers. This makes it easier for people to get loans and can increase demand for things like home loans. Banks benefit from this because they can lend out more money, and the economy benefits from increased money flow as the cost of borrowing goes down. In addition to loans, banks also adjust interest rates on things like savings accounts and fixed deposits based on the central bank’s interest rate. This benchmark rate is crucial in determining all kinds of interest rates set by banks.
Similarities & Differences Between Repo Rate and Bank Rate
The Repo Rate and Bank Rate are both used by the Reserve Bank of India (RBI) to keep an eye on economic activity and money flow. The main difference is that with Repo Rate, the government securities are pledged to the RBI in exchange for a loan, whereas with Bank Rate, there is no such requirement. Here are some similarities and important differences between the two rates.
Similarities
Both Repo Rate and Bank Rate affect the availability of money and help control inflation. Banks and financial institutions are required to pass on the benefits of interest rate cuts to their customers, which means they need to reduce their Base Rate. The Base Rate is the minimum interest rate at which banks can lend money to their customers, and the RBI determines it. When the Base Lending Rate goes down, loans become more affordable, resulting in lower Equated Monthly Installments (EMIs).
Dissimilarities
The differences between the two are:
- Commercial banks and financial institutions borrow money at Bank Rate with no security, while securities are used as collateral for loans at Repo Rate.
- Bank Rate is usually higher than Repo Rate, as the RBI lends loans without security in the case of Bank Rate.
- Loans at Bank Rate are typically given for a longer period of time, whereas loans at Repo Rate are intended for a shorter period of time.
- Bank Rate has a direct influence on the loan rate, whereas banks may take some time to adjust loan interest rates in response to changes in the repo rate because it is for a shorter period of time.
- Repo Rate typically affects big loans such as home loans.
Comparison with Reverse Repo Rate (RRR)
In the Indian economy, the Reserve Bank of India (RBI) determines two important policy rates: the Repo Rate and the Reverse Repo Rate (RRR), both of which are part of the Monetary Policy. While the Repo Rate is the interest rate at which banks can borrow money from the RBI, the RRR is the interest rate at which the RBI borrows money from banks by pledging securities as collateral. Both of these transactions are short-term, usually overnight.
- When the Reverse Repo Rate is high, banks deposit their extra funds with the RBI to earn a higher interest rate than lending to customers.
- Banks can earn a higher interest by lending to the RBI against government-backed securities instead of lending to customers.
- When the Reverse Repo Rate is low, banks are discouraged from depositing their extra funds with the RBI and may choose to lend more to customers to make more profits.
- Banks may prefer lending to customers instead of the RBI when the Reverse Repo Rate is low as they can earn a higher interest rate.
| What | Repo Rate | Reverse Repo Rate |
|---|---|---|
| Borrowing / Lending | Banks borrow RR loans from RBI | Banks lend Reverse Repo Rate loans to RBI |
| Collateral | Banks provide securities to take RR loans | RBI provides securities to take Reverse Repo Rate loans or bank deposits |
| Control of inflation | Both are a part of LAF and help control inflation by lowering money flow and slowing down the economy | RRR incentivizes banks to deposit money in RBI whereas RR defers borrowing loans from RBI to avoid high-interest |
| Economic activities | Low rates pace up economic activities by increasing money supply | Low rates promote banks to lend to customers rather than have RBI deposits |
| Dependency | RRR is dependent on Repo Rate | RRR is always lower than RR because the spread between the two is RBI’s income |
| Current rates | Repo Rate is 6.50% | Reverse Repo Rate is 3.35% |
Also Read: Repo Rate vs Reverse Repo Rate
Conclusion
In conclusion, the Repo Rate is a critical tool used by the Reserve Bank of India to regulate inflation and maintain economic stability. The RBI takes a contrary position in response to rising or falling inflationary pressures, using the rate to contract or stimulate the economy accordingly. Additionally, changes to the Repo Rate have a significant impact on lending practices and loan rates, including home loans, which may fluctuate with changes to the rate.
