The Effect of the Repo Rate on the Economy
The repo rate has a huge impact on a nation’s economy as it is essential to regulate the cash flow in the market. The Indian monetary policy controls and regulates the repo rate depending upon the market’s liquidity and inflation cash flow. Additionally, the repo rate directly affects the borrowing capacity of banks as the repo rate is higher borrowing capacity of banks gets reduced. Repo rates play a major role in controlling inflation in the country for example if there is high inflation RBI increases the repo rate thus reducing the cash flow in the market. As the cash flow slows down production capacity and investment slows down thus pulling the inflation rate down. While on the other hand, RBI only decreases the repo rate when there is a fall in the inflation rate thus, this situation encourages banks to borrow money from RBI.
However, there are negative impacts on the repo rate as well, for example during a rise in inflation RBI increases the repo rate thus resulting in decreased cash flow leading to a fall in the production capacity of industries, and thus resulting in a price hike in necessary goods and services and also leading to unemployment. While on the other hand, RBI tries to lower the repo rates to pump more funds and thus increase the liquidity in the market. The repo rates of RBI and the interest rates on loans of commercial banks are proportional to each other If the repo rates get reduced interest rates on loans to get reduced and vice versa. As soon as the repo rates fall investors borrow a huge sum of money from the banks and invest it in multiple sectors thus leveraging the economy of the country.
Impact of Repo Rate and Reverse Repo Rate
Current Repo Rate is 6.25 percent (According to 12th December 2022), after increasing 35 basis points (bps). The repo rate is sometimes referred to as Repurchasing agreement rate or repurchasing order rate; which is the rate of interest that commercial banks need to pay to the Reserve Bank of India on the borrowed amount. While borrowing a significant amount from the RBI, commercial banks need to sell their securities to the RBI to ensure fund security in case of a shortfall of funds and maintain liquidity. The Repo rate plays an important role in the economic growth of the nation and has a huge impact on inflation as well thus RBI uses it as its main tool to control inflation.
While on the other hand, the reverse repo rate is contrary to the Repo rate, and commercial banks receive handsome interest on their deposited funds from the RBI. Thus the rate of interest paid by the RBI to the commercial banks for their funds is referred to as the reverse repo rate. For example if a bank borrows a sum of Rs 500 crores from RBI at a rate of 4% then after 1 year, the bank will need to repay Rs. 520 crores.
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