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India’s current repo rate is 6.25%. It is up 35 basis points in 2022. I’m sure you’ve read this all over the internet, but what exactly does it mean and why is it important?
Don’t worry, in this article we’re going to tell you everything the repo rate is, right down to how it affects the economy.
What is the repo rate?
The rate at which the RBI lends money to domestic banks is known as the repo rate or repurchase agreement.
The repo rate is a benchmark rate at which banks borrow money from the Reserve Bank of India (RBI). It is also known as the “buyback rate” as it refers to the rate at which banks can borrow money by selling their securities to the RBI and buying them back at a later date.
If the repo rate rises, the banks have to pay more money than interest to the RBI and in turn pass this premium on to customers. So if the repo rate goes up, borrowing becomes more expensive for the general public.
How does the repo rate work?
The Central Bank of India uses the repo rate to control the flow of money in the market. How? Let’s explain.
To curb inflation, the RBI raises the repo rate. When banks have to pay higher interest rates on their loans, they limit their borrowing, which in turn reduces the amount of money that flows into the market and helps curb inflation to some extent.
In the event of a recession, repo rates will also be lowered to keep enough money in the market as banks can then borrow more from the RBI and lend more to people.
Easy right?
But all of this would certainly have an impact on the country’s economy – read on to find out how.
How does the repo rate affect the economy?
So we already know that the repo rate is a tool to control the flow of money, inflation and liquidity in our country.
Now let’s look at the impact on our economy.
During inflation, when the RBI raises its repo rate, investments and money supply slow companies and sectors in the market. This in turn hampers the growth of the economy while controlling inflation.
The opposite is also true. If the RBI has to Control excess funds in the market, it lowers the repo rate. Then companies and industries have an influx of investment and an overall boost to economic growth.
In this way, the repo rate can both boost and dampen the growth of the Indian economy.
What is the reverse repo rate?
The reverse repo rate is a mechanism used to absorb market liquidity and reduce investors’ ability to borrow money.
Reverse repo rate is when the RBI borrows money from banks (in cases where the market is overflowing with funds). The banks receive interest on their securities from the RBI.
So, during high inflation in the market, the RBI increases the reverse repo rate.
Banks can now get higher interest rates on their holdings from the RBI. They add their excess money to RBI’s funds and have limited money to lend to people. This helps in lowering inflation.
What is the difference between repo rate and reverse repo rate?
Here are some differences between repo set and reverse repo set:
repo set | reverse repo set |
---|---|
It is the interest rate that banks pay to the RBI for the loans they make. | It is the interest rate that the RBI pays the banks for loans from them. |
It is higher than the reverse repo rate. | It is lower than the repo rate. |
It is used to control inflation in the market. | It is used to control the excess money flow in the market. |
Securities are sold that can be bought back at a later date. | It involves transferring funds from one account to another. |
The current repo rate in India is 6.25%. | The current reverse repo rate is 3.35%. |
Conclusion
In summary, the repo rate is the rate at which the RBI lends money to other banks and controls inflation. The reverse repo rate is the tool that RBI uses to lower additional cash flow and lending.
These are two extremely important mechanisms that the central bank has used. The repo rate and reverse repo rate can even affect the overall economy of the country on a large scale. If we educate ourselves on this topic, we stay up to date and counteract inflation in the long term. Consider these mechanisms carefully before taking out a loan or making any long-term financial decisions.
frequently asked Questions
India’s repo rate is currently 6.25% (as of December 2022).
India’s reverse repo rate is currently 3.35% (as of December 2022).
The Monetary Policy Committee (MPC), chaired by the Governor of RBI, sets the repo rate based on the latest inflation and tax estimates.
Repo rates affect almost all types of large loans, including home loans, vehicle loans, and personal loans.
The country’s repo rate directly affects the average person who borrows or lends money. An increase in the repo rate increases the interest charged on most loans that a person takes out.
The repo rate usually has a positive effect on fixed-term deposits. The right fixed-income instruments can yield even higher returns if the country’s repo rate rises.
Increasing the repo rate can severely affect the economy and even slow its growth. In essence, an increase in interest rates can lead to an overall reduction in purchases and overall production of goods and services.
The central bank charges a certain interest rate when making loans to commercial banks and other financial institutions such as NBFCs. This interest rate is known as the bank interest rate.