Repo Rate

Latest Repo Rate Updates 2024

8th August 2024 – The government has kept the repo rate at 6.50%, unchanged from the last update.

What is Repo Rate?

Repo rate or repurchase option rate is the rate at which the RBI lends money to commercial banks in exchange for securities. The commercial bank and the central bank, or RBI, would come to an arrangement to repurchase the securities at a predetermined cost.

This is carried out when banks are short on cash or must maintain liquidity in the face of uncertain market conditions. The RBI uses the repo rate to control inflation. Let’s start by understanding how repurchase options work.

Understanding Repurchase Agreements or Repurchase Options

When a commercial bank is short on funds, it may enter into an agreement with the RBI.

Under this agreement, the commercial bank sells government securities to the RBI in exchange for cash. Later, the commercial bank buys these securities back at a higher price.

Repo rate determines the price at which the bank buys the securities back from the RBI. 

Repurchase agreements facilitate short-term borrowing and lending of funds between banks and other financial institutions in India. They are an important source of liquidity for commercial banks, especially in times of cash shortfall.

Current Repo Rate in India

The current repo rate in India is 6.50%, after the recent MPC Meeting in June. 

The Reserve Bank of India (RBI) uses repo rate to control the economy and curb inflation. The last repo rate hike was in February, when the MPC hiked the repo rate by 25 basis points to 6.50%.

Historical Repo Rates in India

How Does Repo Rate Work?

All banks in India can approach the RBI and request a loan in times of fund crunch. The RBI enters into repurchase agreements (repo) with commercial banks. The interest that banks pay for this repo is called the repo rate.

An increase in repo rate means banks borrowing money from RBI will pay higher interest rates. As a result, commercial banks will borrow less money, thereby lowering money availability in the market, which curbs inflation.

RBI also lowers repo rates under certain macroeconomic conditions such as recession. The working of repo rate is closely tied to the working of the economy as a whole. 

Calculation of Repo Rate

The RBI calculates repo rate based on several economic factors and considerations. The process of calculating the repo rate involves the following steps:

1. Economic Analysis: The RBI’s Monetary Policy Committee (MPC) assesses various macroeconomic indicators and economic data to gauge the overall health of the economy. This analysis includes factors like inflation, GDP growth, industrial production, employment figures, global economic conditions, and other relevant economic indicators.

2. Inflation Targeting: One of the primary objectives of the RBI is to maintain price stability, specifically to control inflation. The MPC sets an inflation target, which is the rate at which the RBI aims to keep inflation within a certain range over a specific time frame. This target guides the decision-making process regarding the repo rate.

3. Demand and Supply of Money: If there is excessive liquidity or an excess supply of money, it may lead to inflationary pressures, and the RBI might increase the repo rate to reduce the money supply. Conversely, if there is an inadequate supply of money, the RBI may reduce the repo rate to encourage borrowing and stimulate economic activity.

4. External Factors: Global economic conditions, geopolitical events, and international trade dynamics also influence the RBI’s decision on the repo rate.

5. Forward-looking Approach: The MPC adopts a forward-looking approach, taking into account both current economic conditions and future projections to determine an appropriate repo rate level.

Based on the above analysis, the Monetary Policy Committee arrives at a decision regarding the repo rate. The RBI announces the repo rate in its bi-monthly monetary policy statements, where they also provide their rationale for the rate change, if any.

How Does Repo Rate Affect Inflation?

Inflation is a time of abnormally high prices. This is caused by high purchasing power in the hands of the people.

In this situation, it is up to the government and the central bank to curb inflation by reducing the people’s purchasing power. 

When the central bank increases the repo rate, commercial banks find it tougher to get money – this means that commercial banks will be more hesitant to lend money to the public. 

When loans are not made readily available to the public, purchasing power comes down. This has a chain effect on the economy which eventually brings prices down.

Repo Rate vs Reverse Repo Rate

The RBI sometimes resorts to borrowing money from banks in times of excess market liquidity. The interest rate that the RBI offers to banks when repaying these loans is called the reverse repo rate.

Repo Rate vs MCLR Rate

An increase in the Repo Rate will lead to an increase in the MCLR rate. This is because when RBI hikes the Repo Rate, banks have to pay more to borrow from the RBI. 

As a result, they increase the MCLR rate to compensate for the increased cost of borrowing. When the MCLR is high, people will hesitate before borrowing money from banks, once again leading to lower purchasing power. 

Impact of Repo Rate on Individuals

The most direct impact of a repo rate hike on individuals is that there is an increase in cost of taking a loan from commercial banks.

Since it becomes more expensive for commercial banks to borrow from the RBI, they might not be able to continue giving loans to individuals at the same rate.

So banks will increase interest rates on loans, making it more expensive for the common man to take out a loan from a bank.

Effect of Repo Rate on Businesses

Just as a hike in repo rate affects an individual’s ability to take out loans, businesses too will find it difficult to raise capital or funding from banks and financial institutions.

Read more: Funding Winter Guide for Businesses

In these times, financial management for businesses becomes incredibly important. Ensuring that business cash flows are as efficient as possible helps in times of cash crunch.

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