What is Repo Rate ? Definition and working

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The repo rate (short for “repurchase rate”) is the rate at which the Reserve Bank of India (RBI) lends money to commercial banks for short-term needs, typically against government securities as collateral. It is a crucial monetary policy tool used by the RBI to control liquidity, inflation, and economic growth in the country.

A clear and educational illustration of the Repo Rate concept. The image depicts a central bank building (labeled RBI) and a commercial bank with a flow of funds between them. The RBI lends money to the commercial bank at a specified rate (labeled Repo Rate), with government securities shown as collateral. Arrows indicate the movement of funds and collateral. Use professional, clean visuals with labels to represent the impact of repo rate adjustments on borrowing costs and liquidity. Add a graph showing rising and falling repo rates to explain the concept visually. - Legal Sandook
A clear and educational illustration of the Repo Rate concept. – Legal Sandook

How Repo Rate Works

  • Repurchase Agreement: When banks face a shortfall of funds, they borrow from the RBI under a repurchase agreement. They sell government securities to the RBI with a commitment to buy them back at a predetermined price and date.
  • Cost of Borrowing: The repo rate determines the cost of borrowing for banks. When the RBI increases the repo rate, borrowing becomes more expensive for banks, leading them to increase interest rates for loans and deposits for the public.
  • Liquidity Adjustment: By adjusting the repo rate, the RBI controls the money supply in the economy.

Objectives of Repo Rate

  1. Control Inflation:
    • If inflation is high, the RBI increases the repo rate to make borrowing costlier, reducing spending and money supply in the economy.
    • Conversely, if inflation is low, the RBI reduces the repo rate to encourage borrowing and spending, stimulating economic activity.
  2. Manage Liquidity:
    • The repo rate helps the RBI regulate the amount of liquidity (cash) in the banking system. Higher rates reduce liquidity, while lower rates increase it.
  3. Support Economic Growth:
    • By adjusting the repo rate, the RBI influences the flow of credit to businesses and consumers, impacting overall economic growth.

Current Trends in Repo Rate

The repo rate is reviewed periodically by the RBI’s Monetary Policy Committee (MPC), usually during its bi-monthly meetings. Changes in the repo rate depend on prevailing economic conditions, such as inflation levels, GDP growth, and global economic trends.

Impact of Repo Rate Changes

  1. Increase in Repo Rate:
    • Borrowing becomes more expensive for banks and the public.
    • Discourages spending and borrowing.
    • Helps control inflation.
  2. Decrease in Repo Rate:
    • Borrowing becomes cheaper for banks and the public.
    • Encourages spending and investment.
    • Aims to boost economic growth.

In summary, the repo rate is a vital tool in the RBI’s arsenal for maintaining monetary stability and fostering a balanced economic environment.

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