Originally Published on 05.03.2015
WHAT IS REPO RATE AND REVERSE REPO RATE ?
The rate at which the Reserve Bank of India lends money to commercial banks in the event of shortfall of funds is known as Repo rate . Reverse Repo Rate is the rate at which RBI borrows money from commercial banks .
Reserve Bank of India as a banker to bankers would extend this facility to provide funds to the banks in case of short of liquidity in the market and borrow the funds in case of surplus liquid funds with the banks . Increase / decrease of the rates by RBI has implications to the commercial banks as their borrowing cost goes up or otherwise . In tern as banks generally pass on such costs to the customers , ultimate cost of borrowing from the banks to the general public will be affected . But banks need not automatically change the rates in case of change of Repo rates .
Reserve Bank of India is concerned about the money supply and its effect on inflation . Hence RBI in its effort to control inflation tries to control the rate at which funds available to the banks Hence it increases or decreases its repo rates to reduce or increase the availability of funds to the market . Inflation going up means that there is more money supply to the availability of goods / services and hence going up of prices of commodities . Reduction of implies reduction of money available to the market for purchase of commodities .
Now with signing of a memorandum with Central Government , RBI has agreed to taget inflation with in an accepted band . Hence it has taken responsibilty to take action to keep inflation within a desired band of 2 % to 6% .
In recent past , RBI has reduced both Repo Rate & Reverse Repo rates many times in order to spruce economic growth .
IMPLICATION OF REPO RATE CUT
1. Banks will reduce their interest rates as they have access to a cheaper fund from RBI . Hence borrowers of banks will be benefited . Corporates. traders who have borrowed will have lesser interest burden and hence their profitability will improve .
2. As loans from banks will become cheaper , borrowing from banks will become attractive especially for housing loans and vehicle loans .
3. As banks reduce interest , existing borrowers will pay less EMI in case of housing loan and vehicle loans . It will be beneficial for middle class borrowers .
4. As bankers need to pay lesser interest on their borrowing , profitability will improve . Stock prices can go up in anticipation of higher profit .
6. As interest burden of corporates will come down , profits can go up . Hence in anticipation , their stock prices go up .
7. Interest rates on deposits can come down and it will have adverse effect on those who are dependent up on such income . Especially retirees depending up on interest income will be affected .
8 As inflation depends up on various factors like vagaries of weather , international supply or demand , government policies , change in Repo rate done in isolation may have very little effect on commodity prices . Hence change in Repo rate may not have any desired effect .