When it comes to handling a country's economy and financial markets, one crucial tool may be found in monetary policy. The repo rate—short for "repurchase rate"—is the name given to this instrument. The repo rate is a benchmark interest rate used by the Reserve Bank of India (RBI) to facilitate the smooth operation of the monetary system.
The word "repo rate" appears frequently in banking and monetary policy conversations. It refers to the interest commercial banks pay to RBI for overnight loans secured by those securities.
The repo rate is a key instrument for RBI to control the monetary base. RBI can change the interest rates charged on loans and deposits by modifying the repo rate, which in turn determines commercial banks' borrowing costs. Several aspects of the economy are sensitive to changes in the repo rate, including inflation, currency exchange rates, and overall economic growth.
The repo rate is determined by the RBI’s willingness to buy or sell government assets to deposit or withdraw funds from the banking sector. When the RBI wants to make more money available, it lowers the repo rate. This lowers the cost of borrowing money from the RBI for financial institutions. The repo rate is increased by the RBI to discourage banks from borrowing money and thereby lower the money supply.
In this post, we'll talk about what the repo rate means, how repo transactions work, and how RBI uses the repo rate to manage monetary policy.Also Read: Income tax slabs in India 2023-24: Old vs new tax regime, deductions and more
What is the meaning of Repo Rate?
Repo Rate in its full form, or "REPO," stands for "Repurchasing Option" Rate. It's also known as the "Repurchasing Agreement."
When people are short on money, they borrow from banks and pay interest on the loans. Similarly, commercial banks and financial institutions can also be short of money. When RBI lends money to commercial banks, it charges those banks interest on the principal amount of the loan.
Repo Rate is the return on investment that banks get when they borrow money against any kind of collateral. Commercial banks sell eligible securities to the RBI, like treasury bills, gold, and bond papers. Banks can buy the securities from the RBI when the loan is paid back. So, it's known as the "Repurchasing Option." If they take out a loan without putting the securities up as collateral, it is at the Bank Rate.Also Read: Fiscal deficit: Meaning, history in India, causes, current deficit and more
Current Repo Rate in India (2023)
On February 8, 2023, the Monetary Policy Committee (MPC) announced that the repo rate had gone up by 0.25 percent to 6.50 percent. During its meeting, the MPC decided to keep the reverse repo rate at 3.35 percent. The new rates for the bank and the marginal standing facility are 5.15 percent and 6.75 percent, respectively.
|Reverse Repo Rate||3.35%|
|Marginal Standing Facility Rate||6.75%|
Repo Rate in India: Historical Trend
By examining the historical Repo Rates in India, we can gain insights into its economic and financial developments. Here is the record of the past Repo Rates in India's history.
|Date||RBI Repo Rate|
How to Calculate the Repo Rate?
The interest rates that commercial banks pay to the RBI or get when they put money in the RBI must be agreed upon and standardised.
To calculate the repo rate, the following formula is used:
Repo Rate = (Repurchase Price – Original Selling Price / Original Selling Price) * (360 / n)Where:
* Repurchase Cost = Original Selling Price + Interest
* Original Selling Cost = Sales Cost of Security
* n = Number of Days to Maturity
How is Repo Rate Used to Control Inflation?
The repo rate is key to keeping inflation under control because it affects the cost of borrowing and, in turn, the amount of money in Indian economy. RBI adjusts the repo rate to manage inflationary pressures and maintain price stability.
- Money Supply Management: When RBI wants to curb inflation, it raises the repo rate, and therefore the cost of borrowing. As a result, banks may reduce their borrowing and lending activities, which decreases the overall money supply in the economy. With less money available, consumer spending and investment tend to decline, which can help cool down inflation.
- Credit Availability: Higher repo rates discourage consumer and business borrowing. When banks face higher borrowing costs, they may pass on the increased interest rates to customers. Then, individuals and businesses may find it less affordable to take out loans. The reduced credit availability dampens demand and helps control inflation.
- Demand-Side Management: By adjusting the repo rate, RBI influences the demand for goods and services. When the repo rate is increased, borrowing becomes more expensive, decreasing consumer spending and investment. This helps prevent excessive demand-driven inflationary pressures in the economy.
- Managing Inflation Expectations: Repo rate adjustments also play a crucial role in shaping inflation expectations among consumers, businesses, and financial markets. A repo rate hike from the RBI signals market participants to anticipate lower future inflation rates and adjust their behaviour. For example, businesses may moderate their price increases, and consumers may delay their purchases.
Repo Rate vs Reverse Repo Rate
Daily short-term liquidity management is handled by RBI and other financial institutions using repo rates and reverse repo rates. Repo rate is the interest rate at which commercial banks borrow funds from the RBI. RBI provides loans to commercial banks in exchange for government debt.
The rate at which commercial banks deposit funds with the RBI is known as the reverse repo rate. Most financial institutions prefer this failsafe method of protecting their surplus funds. The term "reverse repo rate" refers to the interest rate that is paid on deposits.
The Reserve Bank of India pays interest on deposits at the reverse repo rate, whereas the repo rate is paid on loans to commercial banks.
Inflation can be managed using the repo rate, while liquidity in the economy can be managed with the reverse repo rate. RBI ensures that the reverse repo rate is always set at a lower rate than the repo rate.
Frequently asked questions
1. What is the Marginal Cost of Funds Based Lending Rate?The maximum interest rate a bank can charge its borrowers is calculated internally using a benchmark rate called the Marginal Cost of Funds Based Lending Rate or MCLR.
2. How is Marginal Cost of Funds Based Lending Rate or MCLR calculated?The Marginal Cost of Funds Based Lending Rate (MCLR) is calculated by taking into account various components of a bank's cost of funds. The formula used to calculate MCLR in India is as follows:
* MCLR = Marginal Cost of Funds + Tenor Premium
* Marginal Cost of Funds (MCF): This represents the weighted average cost of various sources of funds for the bank.
* Tenor Premium: This represents an additional component that reflects the bank's expectations of future interest rate movements. It is added to the Marginal Cost of Funds to arrive at the final lending rate for different tenors.
3. What types of loans are impacted by the reduction or increase in repo rates?Personal, vehicle, housing, and gold loans are all vulnerable to changes in the repo rate.4. How often can banks change loan rates that are tied to the repo rate?The Reserve Bank of India has mandated a quarterly review of all interest rates pegged to external benchmarks.
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