What is Repo Rate and Reverse Repo?

The world of finance and economics has many important concepts that help us understand the overall health of the economy. One such important term is the Repo Rate. This term is often discussed because it plays a key role in how financial markets work. It is also a crucial tool for banks to manage monetary policies. This guide will explain what the Repo Rate is, why it is important, and how it affects different people.

What is Repo Rate?

The repo rate (short for Repurchase Rate) is the interest rate at which the Reserve Bank of India (RBI) lends money to commercial banks in the event of any shortfall of funds. It is a crucial tool used by the RBI to control inflation, liquidity and stabilize the country's economy. By adjusting the repo rate, the RBI can influence the liquidity and overall money supply in the financial system.

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. 

How Does Repo Rate Work?

When commercial banks need money, they can borrow it from the RBI at the repo rate. To get these funds, banks have to give the RBI something valuable, like government bonds, as a guarantee.

Here's an example to make it clear:

Example: Imagine a bank needs ₹1 crore. They borrow this amount from the RBI at the repo rate of 6%. The bank gives government bonds worth ₹1 crore to the RBI as collateral. If the repo rate goes up to 7%, it becomes more expensive for the bank to borrow money. This means the bank might charge higher interest rates on loans to customers, making it harder for people and businesses to borrow money.

On the other hand, if the repo rate drops to 5%, it’s cheaper for the bank to borrow money. This can lead to lower interest rates on loans, encouraging more people and businesses to take loans and spend more.

How Does RBI Calculate Repo Rate?

The RBI determines the repo rate based on several economic factors, including:

Inflation: If inflation is high, the RBI may increase the repo rate to curb excess money supply.

Economic Growth: To stimulate economic growth, the RBI might lower the repo rate, making loans cheaper.

Liquidity Conditions: The RBI assesses the liquidity conditions in the financial system to decide the repo rate.

Global Economic Conditions: International economic trends can also influence the RBI's decision on the repo rate.

Latest Update on Repo Rate

The current Repo Rate in India has been fixed at 6.50% as per the announcement made by the government on 8th February 2024.

These are the latest Repo Rate and Reverse Repo Rate:

Historical Repo Rates

Over the years, the repo rate has fluctuated based on the economic conditions of the country. Following is the list of the historical Repo Rates in India:

What is Reverse Repo Rate?

The reverse repo rate is the interest rate at which the RBI borrows money from commercial banks. It is the opposite of the repo rate. Banks lend money to the RBI to earn interest on their surplus funds. The reverse repo rate is a tool used by the RBI to absorb liquidity from the banking system and control inflation.

Difference Between Repo Rate & Reverse Repo Rate

The repo rate and reverse repo rate are critical tools used by the RBI to manage the country's monetary policy. By adjusting these rates, the RBI can control inflation, influence economic growth, and ensure financial stability. Understanding these rates and their implications can help individuals and businesses make informed financial decisions.