REPO RATES

Originally Published on 05.03.2015 ​

WHAT IS ​REPO RATE ? 

FOR  LATEST NEWS ON REPO RATE  , CLICK HERE 

 Editor's Note dated  05.05.2022  :  RBI  has enhanced  its repo rate by 0.40 % to 4.40 %   yesterday   which will have  consequences on     Banks,  stock markets  , inflation  , growth  and commodity  prices   . You   can have a  general  view  of the effects  of the move by   RBI  by reading the article below. 

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 turn 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 . 

 Earlier  the governor of  RBI was deciding   on the REPO Rates  . Now with signing of  a memorandum  with Central Government ,  RBI has  agreed  to target inflation   with in an accepted band  .  Hence  it has taken responsibility to take action to keep inflation within  a desired band  of 2 % to  6%  . 

​Monetary policy committee  of reserve Bank of India   tweaks  Repo rates  during their bimonthly meetings ​

Monetary policy Committee of RBI

The Monetary Policy Committee of Reserve Bank of India  is responsible for fixing Repo and other  benchmark interest rates in India. The meetings of the Monetary Policy Committee ( MPC ) are held at least 4 times a year (specifically, at least once BIMONTHLY) and it publishes its decisions after each such meeting.

The committee   has  six members - three    members  from the Reserve Bank of India and three external members nominated by the Government of India.  The members  are   to   keep the deliberations secret atleast for  a "silent period" seven days before and after the rate decision for "utmost confidentiality".  The Governor of Reserve Bank of India is the chairperson  of the committee. Decisions are taken by majority with the Governor having the casting vote in case of a tie.

The current mandate of the committee is to maintain 4% annual inflation with an upper tolerance of 6% and a lower tolerance of 2%.[

IMPLICATION OF REPO RATE CUT / HIKE

1. Banks     will reduce  their interest rates  as they have access to  a cheaper fund from RBI  ,if Repo Rate is cut  .   Interest rates   at which banks lend will   go up   , if Repo Rate is hiked . Hence borrowers  of banks will be benefited with lesser interest burden / increased   interest  burden .  In case   of  Repo rate lowering , Corporates. traders   who have borrowed will have  lesser interest burden and hence  their profitability will improve . 

2.  As loans from banks will become cheaper or costlier as   per Repo rate  movement ,   borrowing from  banks will become attractive or     expensive  especially for housing loans and vehicle loans . 

3. As banks reduce  or  increase  interest , existing borrowers   will pay less or  more EMI in case of housing loan and vehicle loans . It will be beneficial  for middle class borrowers or adverse in case  of hike . Some  loans may be directly linked  to prevailing  Repo rate and  hence  may automatically  change  according to Repo movement . 

4. As bankers need to pay lesser or higher  interest on their borrowing ,  profitability will improve or otherwise.  Stock prices  can go up    or come down in anticipation of higher / lower profit . 

6. As  interest burden of corporates will come down or go up  ,  profits can go up or come down  . Hence  in anticipation , their  stock  prices go up  or come down  . 

7. Interest rates on deposits can come down or goes up   as Repo rate movement .   and it will have adverse  or  beneficial    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 .    

9.   REPO RATE LINKED   INSTRUMENTS  :   Interest rates   on some  deposits and loans are    directly linked   to the  prevailing Repo rates and   hence automatically move according to the  movement of  Repo rates   . 
Some such instruments are 

Repo Rate  linked Lending rates ( RRLL )   : ​​  Many borrowers would have taken car loans / home loans    with    RRLL  interest rates  .  Hence  hike in repo   will automatically move up borrowing cost .     You can check whether  your loans are directly linked  to  Repo rates  or not by going through the  loan agreement . 

Repo Rate  linked  Deposits  rates : Some banks have  linked  their   deposit rates  directly to prevailing  Repo Rates . For example , SBI has linked  Savings Bank interest rates to Repo Rate . 

10 .    With  increase in deposit rates  , savings will be promoted   while  borrowings  will be reduced   to avoid interest burden .  Thus  less  money will be available in the market    and liquidity  will be  affected . With  tighter money conditions   ,  demand   will be affected     and   It is expected   to have adverse effect on the liquidity of the system .