As everyone may be aware that Reserve Bank of India (RBI) has reduced the repo rate by 25 bps to 6.25%.
But first of all let us understand some of the terminologies and correlations which can help us interpret the effects of reduced repo rate.
Repo Rate: It is a rate at which scheduled commercial banks can borrow money overnight from RBI. So, it is a short term borrowing by scheduled commercial banks from RBI.
BPS: Many of us find it difficult to interpret bps. It is abbreviation of Basis Point. It is 1/100th of 1%. Hence, 1 bps = 0.01%. So, when it is declared that RBI reduced interest rate by 25 bps then it means that rates are reduced by 0.25%.
The relation between the interest rate (repo rate) and the inflation rate is inverse. The repo rate is increased when the inflation rate is in an increasing trend.
Now, let us understand why repo rates are increased and decreased.
There are many micro and macro factors which causes the repo rate to increase/decrease. But majorly when we hear or read that RBI has made some changes in the repo rate, it means that there is some fluctuation in the inflation rate of the economy.
One cannot be wrong if he/she is making a view regarding the inflation pressure on the economy with the changes in the repo rate made by RBI or vice versa.
Who changes the repo rate?
The topics such as repo rate, reverse rate, cash reserve ratio, etc are covered under the monetary policies formed by the government. Reserve Bank of India has the ultimate power to frame monetary policies for the Indian economy. But who is exactly RBI?
Well, one can say that there has to be a committee who frames policies. The committee is called as Monetary Policy Committee (MPC) which is formed of 6 members. The current RBI governor is Urjit Patel who is leading MPC.
Well, analysts say that seeing the downward slope of the inflation rate in the past period and as the food inflation momentum as moderated (especially the pulses price), the repo rate has been further reduced.
It is to be noted that since January 2015, a total of 175 bps drop down is there.
Sure it is a great news for the borrowers as they can now borrow the same amount of money at a lesser rate of interest compared to earlier borrowing rates.