Understanding Repo Rate: A Comprehensive Guide

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What is Repo Rate and Reverse Repo?

The realms of finance and economics are filled with concepts and terms that hold significant importance that result in putting light on the overall health of economics. Among many, one such term is Repo Rate. This is an often discussed term in the metric of economics being a fulcrum in the functioning of the financial market. It also serves as the most essential tool for the banks in order to manage monetary policies. This comprehensive guide weaves the intricacies of the Repo Rate, its importance, and its impact on the stakeholder.

Repo Rate: What is it? 

Repo Rate, also known as the Repurchase Rate, is the rate at which the central bank tends to lend money to commercial banks for a short period of time usually overnight. It is the most essential tool that helps in maintaining liquidity, inflation, and economic growth within the country. 

Repo Prate forms a vital part of the monetary policy skeleton and is usually established by the central bank to meet macroeconomic objectives. It is sometimes referred to as a repurchasing agreement or repurchasing option. Inflation is also controlled by using the same rate. 

The RBI increases the repo rate in an inflationary environment to discourage commercial banks from borrowing money from the Indian Central Bank. Refusing to take money from central banks, commercial banks help control inflation by reducing the amount of money in circulation. On the other hand, the opposite stance is taken if there is no inflation in the country.

Latest update on Repo Rate

The Reserve Bank of India, or RBI, has increased repo rates by 25 basis points (BPS). The repo rate increased from 6.25% to 6.50% at this time. It has been decided to increase the repo rate in order to lower retail inflation. December 2022 saw a 35 basis point increase in the repo rate. For the upcoming fiscal year, the Monetary Policy Committee (MPC) also projected a 6.4% growth in GDP. It is anticipated that retail inflation will reach 5.3% in FY24. 

When the repo rate rises, so will the rates on home loans. An increase in house loan interest rates directly results in higher EMI. The affordability of homes will surely be impacted by the increasing repo rate. Frequent rate hikes may temporarily delay a purchase, but they have minimal effect on the housing market overall. The little increase in purchase costs would ultimately level out and be eclipsed by a consistent increase in capital values over a period of sustained end-user-led recovery in the real estate sector. 

Our estimations indicate that there is a greater demand for luxury real estate than there is in other market segments, therefore the rise will not have a significant impact here.

Reverse Repo Rate

The term "reverse repo rate" refers to the interest rate at which commercial banks in India lend money to the RBI. At its bimonthly meeting, the Monetary Policy Committee makes that determination. The commercial bank is borrowing because it believes that the RBI would provide them with a competitive interest rate on any extra money. Money supply and reverse repo rate are inversely connected; a decrease in the former causes a rise in the latter.

What separates the reverse repo rate from the repo rate?

The repo rate and reverse repo rate differ in the following ways:

  • A repo rate is the interest rate at which the RBI lends funds to commercial banks.
  • Commercial banks can receive interest by depositing excess funds to the Reserve Bank of India at the reverse repo rate.
  • These rates are compounded annually.
  • Below is an example of a repo rate: For example, after a year, HDFC Bank would have to repay the Rs 10 crore it borrowed from the RBI at a rate of 4.40% with Rs 10.24 crore.
  • The following is an example of a reverse repo rate: For example, after a year, Axis Bank would get Rs 10.34 crore back from the RBI if it deposited Rs 10 crore in surplus cash at a rate of 3.35%.

Effects of Repo Rate

An essential instrument for the country's economic expansion is the repo rate. It also has a major impact on the country's inflation rate and helps maintain control over the money supply and liquidity. When inflation gets out of control, the RBI raises the repo rate to curb the flow of money. 

A higher rate will result in increased borrowing costs for banks. It also slows down investment and the flow of money into the economy. As such, it hurts the economy and helps to keep inflation under control. If the RBI feels that the economy needs more money, it lowers the repo rate. Instead of lending the money to other people in this manner, commercial banks are recommended to borrow it from the RBI. 

Conclusion

The repo rate is the interest rate at which other commercial banks can borrow money from the Reserve Bank of India (RBI). On the other hand, commercial banks can deposit excess cash with the RBI and get a competitive interest rate at the reverse repo rate. 5.90% is the current repo rate, and 3.35% is the reverse repo rate. The Monetary Policy Committee (MPC), which determines these rates, meets every two months under the direction of the RBI governor.

  • How do you understand the repo rate?

  • What is the entire definition of a repo in banking?

  • Is a higher repo rate better?

  • What happens as the repo rate rises?

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