Q. Consider the consequences of an increase in the Repo Rate by the Reserve Bank of India:
1.It leads to an increase in the cost of borrowing for commercial banks, subsequently pushing up their Marginal Cost of Funds Based Lending Rate (MCLR).
2.It tends to decrease the returns on the short-term Government securities (G-Secs) traded in the money market, as banks prefer to lend to the RBI at the higher Repo Rate.
Which of the statements given above is/are correct?
Answer: A
Notes:
Explanation:
Statement 1: Correct. The Repo Rate is the benchmark policy rate. An increase makes it more expensive for banks to borrow from the RBI, increasing their overall cost of funds and leading to an increase in their lending rates (like MCLR/EBLR), thereby making credit costlier for consumers and businesses.
Statement 2: Incorrect. An increase in the Repo Rate means higher interest rates in the economy. Bond prices (including G-Secs) move inversely to interest rates. Therefore, when the Repo Rate rises, the price of existing bonds falls and the yield (return) on these bonds increases, making them a more attractive investment.
