Repo Rate

The repo rate, often seen in news, is a significant monetary policy tool used by RBI to manage liquidity and control inflation in the economy. It is the interest rate at which commercial banks borrow from the central bank in case of a shortfall of funds, with objectives to ensure stability and stimulate economic growth. By manipulating this rate, the central bank such as RBI can control the cost of borrowing, thus indirectly controlling spending habits, investments, and overall economic activity. In this article, you will learn about definition of repo rate, what is the impact of increase or decrease of repo rate on economy and factors influencing repo rate, which are important for GS Paper-3 Economy of UPSC IAS Exam. To explore more interesting Class 12 Economics concepts, check out other articles of IASToppers.  

Table of Contents

• What is Repo Rate?
• Objectives of Repo Rate
• How Repo Rate Affects the Economy
• Factors Influencing Repo Rate Change
• What is the Difference between Repo Rate and Reverse Repo Rate?
• What is Repo Linked Lending Rate (RLLR)?
• Frequently Asked Questions Repo rate

What is Repo Rate?

• Repo Rate stands for Repurchasing Options.
• Repo Rate is the interest rate at which Reserve Bank of India (RBI) gives loans to commercial banks under the Liquidity Adjustment Facility (LAF).
• These short-term borrowings, including overnight repos, 7-day repos, and 14-day repos, are typically used by banks to meet their liquidity needs.
• The central bank, such as RBI, receives securities (e.g., Treasury Bills, gold, and bond papers) from commercial banks in exchange for short-term funds through repurchase agreements. The commercial banks then agree to repurchase these securities at a predetermined price.

Objective of Repo Rate

• The central bank of any country, such as the Reserve Bank of India (RBI) in India, uses this rate as a monetary tool to:
  • Maintain liquidity
  • Control inflation
  • Regulate the money supply

How Repo Rate Affects the Economy?

This rate is a critical component of monetary policy, as it directly influences banks’ borrowing power and controls the money supply.

Regulating inflation and liquidity in the market are the two primary goals of repo rate.

• Controlling Inflation: During times of high inflation, the central bank or RBI increases the repo rate to reduce the flow of money in the economy. This makes borrowing by businesses and industries more expensive, which in turn slows down money supply as well as investment capabilities in the market. As a result, inflation is brought under control.
• Managing Liquidity: Based on the macro-economic situation of the country, the RBI changes Repo Rate to increase or decrease liquidity in the economy. Decreasing the rate means businesses and industries can take loan at lower interests’ rates and thus makes borrowing cheaper. This means more and more people are likely to take loan for their economic activities like business expansion. This process increases the money supply in the market and ultimately boosts economic growth. On the other hand, increase in rate implies decrease in money supply and dampen economic growth.

Factors Influencing Repo Rate Changes

Rate changes occur in response to various economic factors. Some of these factors include:

Increase in Repo Rate

1. High inflation rate in the economy
2. Risk of currency depreciation
3. Need to curb speculations in foreign exchange areas
4. Possibility of asset bubbles due to excessive capital formation

Decrease in Repo Rate

1. Controlled inflation and fiscal deficit
2. Economic slowdown prompting a more accommodative monetary policy
3. A stable balance of payments situation

Repo Rate History Chart

Below is the history of Repo Rate trend in India since February 2021.

What is the Difference between Repo Rate and Reverse Repo Rate?

Parameter	Repo Rate	Reverse Repo Rate
Meaning	Rate at which RBI lends money to banks	Rate at which RBI borrows money from banks
Interest Rate	Higher than the reverse repo rate	Lower than the repo rate
Mechanism	Involves the sale of securities which would be re-purchased in future.	Involves the transfer of money from one account to another.
Application	Used to control inflation and deficiency of funds	Used to manage cash-flow

What is the Difference between Bank Rate and Repo Rate?

Parameter	Bank Rate	Repo Rate
Meaning	It’s the rate at which the RBI lends loans. Banks repay both the principal amount and interest at the bank rate.	Also known as policy repo rate, it the rate at which banks repurchase the securities from RBI.
Objective	It is used to meet the long-term lending requirements of banks.	It is used as a monetary tool to determine liquidity rate in the market, catering to short-term financial needs.
Collateral	They are unsecured, meaning no collateral is needed.	Repo rate loans require collateral such as government securities or bond papers.
Tenure	It can have a period of up to 28 days.	They are typically short-term, having a one-day tenure.
Interest Rate	It is higher than the repo rate, reflecting the higher risk associated with the unsecured nature of these loans and the longer lending period.	It is always lower than the bank rate.
Direct Impact on Customers	An increase in the bank rate can directly affect the lending rates offered to customers, making loans more expensive and potentially slowing down economic growth.	An increase in the repo rate doesn’t usually impact customers directly as this is often managed by the banks themselves.
Role in Market Liquidity and Inflation	Both rates are used by the RBI as tools to control market liquidity and inflation. The bank rate tends to have a more long-term impact.	While also used to control liquidity and inflation, the repo rate tends to have more short-term impacts.

What is Repo Linked Lending Rate (RLLR)?

• The Repo Linked Lending Rate (RLLR) refers to a lending rate that’s tied to the Reserve Bank of India’s repo rate, with the actual RLLR interest being dependent on factors such as loan amount, loan-to-value, borrower’s risk group, and a possible bank-charged spread or margin.
• A Repo Linked Lending Rate -based home loan operates on the principle that changes in the RBI’s repo rate directly influence the home loan interest rate, making it fluctuate in accordance with repo rate adjustments.

Conclusion

Repo Rate serves as a critical tool for the Reserve Bank of India (RBI) to regulate liquidity, manage inflation, and control the money supply in the Indian economy. A balanced approach in setting the rate will help maintain stability in the Indian economy while promoting sustainable growth and addressing inflationary concerns. Encouraging open dialogue and transparency in monetary policy decision-making will further strengthen public trust in the government’s ability to manage economic challenges.

Ref: Source-1

Other Articles in Economy
Long Term Repo Rate Operations (LTRO)	Value Added Tax (VAT)
Regional Rural Bank	Small Finance Banks (SFB)
Marginal Cost of Funds based Lending Rate (MCLR)	Payment Banks

FAQs (Frequently Asked Questions)