The repo rate in India

What is the News?

Reserve Bank of India has announced that the RBI’s Monetary Policy Committee(MPC) had held an ‘off-cycle’ meeting at which it had decided unanimously to raise the policy repo rate by 40 basis points to 4.40% with immediate effect.

What is Repo Rate?

The Repo Rate is one of several direct and indirect instruments that are used by the RBI for implementing monetary policy. 

RBI defines the repo rate as the fixed interest rate at which it provides overnight liquidity to banks against the collateral of government and other approved securities under the liquidity adjustment facility(LAF).

In other words, when banks have short-term requirements for funds, they can place government securities that they hold with the central bank and borrow money against these securities at the repo rate.

What is the importance of Repo Rate?

Firstly, it serves as a key benchmark for the lenders to in turn price the loans they offer to their borrowers.

Secondly, it allows central banks to control the money supply within economies by increasing or decreasing the availability of funds.

How does Repo Rate function as a monetary tool?

Repo Rate functions as a monetary tool by helping to regulate the availability of liquidity or funds in the banking system. 

For instance, when the repo rate is decreased, banks may find an incentive to sell securities back to the government in return for cash.This increases the money supply available to the general economy. 

Conversely, when the repo rate is increased, lenders would end up thinking twice before borrowing from the central bank at the repo window thus, reducing the availability of money supply in the economy.

What impact does Repo Rate have on inflation?

Inflation can broadly be demand-driven price gains or a result of supply-side factors that in turn push up the costs of inputs used by producers of goods and providers of services, thus spurring inflation.

Changes to the repo rate to influence interest rates and the availability of money supply. It primarily works only on the demand side by making credit more expensive and savings more attractive and therefore dissuading consumption. 

However, they do little to address the supply side factors, be it the high price of commodities such as crude oil or metals or imported food items such as edible oils.

Source: The post is based on the article “The repo rate in India” published in The Hindu on 17th May 2022.