We will talk a little about the repo rate before going into the depth of the topic of the article.
Suppose you want to buy a home but do not have sufficient funds to purchase it. So, you will go to the bank to take a home loan. But the bank will give the loan with a certain percentage of interest, which you have to return to the bank within the given period as decided by the bank. Sometimes, commercial banks such as SBI face a shortage of money. In such a case, they take the loan from the central bank of the country, which is the RBI. The RBI lends the required money to the commercial bank with a certain percentage of interest rate.
Likewise, when you go to the bank to deposit the cash, the bank pays an interest on the deposit with a certain percentage.
Repo Rate and Reverse Repo Rate
Let us understand the repo rate and reverse repo rate separately to have a better understanding of their effects on the economy.
The repo rate is the interest rate decided by the central bank of the country (RBI). We have already discussed about commercial banks taking funds from the central bank whenever there is a shortfall of liquid cash. Then, the central bank (RBI) grants money to the commercial bank at a certain percentage of interest. This rate of interest is called the repo rate. The lending at repo rate is the small-term lending whose duration varies from 1 day to 14 days. The repo rate is also called ‘Repurchase Agreement’ or ‘Repurchase Option.’
Now let us explore the reverse repo rate. Sometimes, commercial banks such as SBI have excess funds or liquid cash, which they do not want. They then try to earn interest with that liquid cash. It is possible that when you give your extra money to the central bank (RBI), they give you interest in return. This interest is the reverse repo rate. So, the interest paid by the central bank (i.e., RBI in India) to the commercial bank when they deposit excess liquid funds to the RBI is called the reverse repo rate.
So, we can also say that the borrower enters into the repo rate, and on the other side, the lender enters into the reverse repo rate.
Both the interest rates, namely, the repo rate and the reverse repo rate, are decided by the RBI. These rates help to maintain the economic strength of the country.
The Impact of the Reduction in Repo Rate on the Economy
The repo rate and the reverse repo rate are both important for the economic stability of the country. To control inflation, the RBI takes into account the repo rate. When inflation rises, the RBI also increases the repo rate. The rise in repo rate will be done to stop the commercial banks from borrowing the funds from the RBI. This will further result in reducing the supply of cash in the economy of the country. This helps to counter the hike in inflation.
Benefit of the Repo Rate Cut
As the interest rates fall, it encourages consumers to spend more. Loans have more interest. Let us take an example of a home loan, which is giving benefits to the real estate sector, resulting in the benefit to the overall economy.
The low-interest-rate will result in low interest in any type of deposit as banks reduce the deposit rates also. The other benefit of lower interest rates is the capital becoming cheaper, resulting in companies expanding their business, which generates even more employment and job opportunities. This process strengthens economic growth.
The inflation and rise in liquidity are the two effects of the repo rate in the economy.
RBI Monetary Policy Reverse Repo Rate
Presently, 4% is the repo rate and 3.35% is the reverse repo rate set by the RBI. The Monetary Policy Committee (MPC) is a six-member committee. The MPC is one of the committees formed by the Reserve Bank of India (RBI). The MPC has kept the rates unchanged. The repo rate has not changed for the tenth time. The last time when the policy rate was revised was on 22 May, 2020.
The repo rate affects the economy. The central bank wants the consumer to carry out the economic activities in the economy; it will minimise the repo rates. If the repo rate is minimised by 50 basis points (bps), it will have an impact on the economy. The RBI enables the commercial banks of the country to cut down the interest rates that they charge and the interest rates they pay on deposits. This will result in encouraging people to spend more money because the savings they have in the bank will pay them a very little amount.