Repo Rate & Reverse Repo Rate: A Detailed Analysis

Understand the significance of Repo Rate and Reverse Repo Rate set by the Reserve Bank of India (RBI) and their impact on the economy and financial markets.

The Reserve Bank of Bank (RBI) as a regulatory authority reviews its decision on continuous basis to keep the reserves with a view to securing monetary stability in the country by taking proper measures including changes in Repo Rate & Reverse Repo Rate, keeping the main objective of country’s growth, in mind.

Meaning of REPO RATE:-

Repo rate is the rate at which money is lent to Commercial Banks by the Reserve Bank of India (RBI), against the securities offered.

For easy & quick understanding, here are few words which need to be read & understood carefully to get the correct and detailed meaning of Repo Rate.

a) Commercial Banks includes:-

Schedule Public Sector Banks,

Scheduled Private Sector Banks,

Scheduled Small Finance Banks,

Scheduled Payments Banks (like India Post, Fino, Paytm, Airtel etc.),

Scheduled Regional Rural Banks,

Scheduled Foreign Bank In India.

b) Reserve Bank of India:

Reserve Bank of India (RBI) (also called Central Bank) is a Statutory Body established for regulating the monetary policy, maintaining financial stability, and supervising the banking sector of the country.

c) Securities offered:

Commercial banks which need money from Reserve Bank of India, required to offer securities like Treasury Bills, Government Bonds etc.,

Repo Rate stands for ‘Repurchase Option’ or ‘Repurchasing Agreement’.

Repo Rate is also termed as Policy Repo Rate by the RBI.

How it works:-

The Commercial Banks used to borrow money from Reserve Bank of India (RBI);

– To maintain liquidity;

– To avoid from cash crunch condition; or

– To maintain cash reserve (CR) as a precautionary measure.

Each time of borrowing, both commercial banks and Reserve Bank of India enters into an agreement called “Repurchase Agreement” with specified amount to be borrowed and interest rate to be served (Repo Rate).

The Commercial Banks are required to pledge their Treasury Bills, Government Bonds or such other Bonds supported by underlying liquid assets of banks.

This will be on continuous basis.

Usually, such borrowings are Short Term borrowings in nature.

The Reserve Bank of India consider the Repo Rate as a Tool in keeping the Inflation under control:-

During high levels of inflation, the RBI makes strong attempts to bring down the flow of money in the economy.  One way to do this is by increasing the repo rate.  This makes borrowing a costly affair for businesses and industries, which in turn slows down investment and money supply in the market. As a result, it negatively impacts the growth of the economy, which helps in controlling inflation.

Even a small rate hike has an impact on the consumers as it makes borrowing from the commercial banks expensive.  All sorts of loans like Home loan, Vehicle loan, Education loan, personal loan, business loan, credit cards, and mortgages are affected by the repo rate hikes.  Also, an increase in borrowing costs discourages the unnecessary spending of common man thereby reducing the demand for goods and services.  This further disrupts the demand and supply chain.

Lowering of Repo Rate:-

When the RBI needs to pump funds into the system, it lowers the repo rate. Consequently, businesses and industries find it cheaper to borrow money for different investment purposes. It also increases the overall supply of money in the economy. This ultimately boosts the growth rate of the economy.

The Impact of REPO RATE:-

Impact on Housing Loan(s):

The Housing EMIs will become expensive.  Either Loan repayment period may be extended or EMIs will be rescheduled, by the banks.

Impact on Fixed Deposits of customers:

The banks will enhance the rate of interest on FDs not in proportion to the enhancement in Repo Rate but in par with other competitive banks, in the money market.

Impact on Stock Market:

Because of high interest rates by the bankers, the Retails investors may hesitate to make fresh investments in the Stock Market.  Also Big Corporates may hesitate to expand their business activity.  High interest rates may crush the profit of the business units, especially MSME sectors.  Thereby the stock market may witness blood-bath for few trading days.

Impact on Economy:

The Repo Rate is a Tool to keep the Inflation under control.  High Inflation is the symptom bad economy.  It sends a strong message to the Central Bank to take proper measure to keep it in control.

At the same time the Central Bank must see that the sufficient cash is available in the market smoothly.

Meaning of REVERSE REPO RATE:-

Reverse Repo rate is the rate at which money is borrowed by the Reserve Bank of India (RBI) from Commercial Banks.

How it works:-

The Reserve Bank of India (RBI) uses the Reverse Repo Rate as a mechanism to absorb the liquidity in the market, thus restricting the borrowing power of investors.

This situation arises when there is excess liquidity in the market.  The banks benefit out of it by receiving interest for their holdings with the Reserve Bank of India.

During high levels of inflation in the economy, the RBI increases the reverse repo.  It encourages the Banks to park more funds with the Reserve Bank to earn higher returns on excess funds.  Banks are left with lesser funds to extend loans and advances to consumers.

“How much do we know about MONETARY POLICY COMMITTEE (MPC) of Reserve Bank?”

How much we know about MONETARY POLICY COMMITTEE (MPC) of Reserve Bank:-

Prior to the establishment of MPC:-

Prior to the establishment of Monetary Policy Committee (MPC), key decisions pertaining to benchmark interest rates used to be taken by the governor of the Reserve Bank of India, on the basis of the recommendations from a Technical Advisory Committee (TAC) with experts from field of Economics, Banking & Public finance.

Since the governor of RBI is appointed person and can be disqualified by the government anytime. This was leading to uncertainty & resulted in friction between the government and the RBI, especially during the times of low growth and high inflation.

After the establishment of MPC in 2016:-

The Monetary Policy Committee (MPC) was established through “The Reserve Bank of India Monetary Policy Committee and Monetary Policy Process Regulations, 2016”.

The Monetary Policy Committee is responsible for fixing the benchmark interest rate in India.

This committee comprises SIX MEMBERS;

a) Three officials of the Reserve Bank of India; and

b) Three external members nominated by the government of India.

The members need to observe a “silent period” Seven days before and after the rate decision for “utmost confidentiality”. The governor of the Reserve Bank of India is the chairperson ex officio of the committee.  Decisions are taken by majority with the governor having the casting vote, in case of a tie.

The monetary policy are published after every meeting with each member explaining his opinions.  The committee is answerable to the government of India if the inflation exceeds the range prescribed for three consecutive quarters.

Presently, the following are the members of the Monetary Policy Committee of RBI:

a) Shashanka Bhide;

b) Rajiv Ranjan;

c) Michael Debabrata Patra

d) Shaktikanta Das; (Governor of RBI);

e) Ashima Goyal; and

f) Jayanth R. Varma.

The previous meeting of MPC held on 8^th February 2023, the MPC decided to increase the REPO rate by 25 basis points.  The following were the members who voted for & against the increase of REPO rate in the meeting;

Voting on the Resolution to increase the policy REPO rate to 6.50 per cent.

* Courtesy: Minutes of MPC Meeting published on 22^nd February, 2023.

* Available @ https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=55267

BASIS POINT or BASE POINT:-

Sometimes we do wonder what is this Basis Point or Base Point that is referred by the Reserve Bank, while taking decision on Repo Rate.

Let us just understand the logic of this Basis Point or “bps”

A basis point (often abbreviated as “bps“) is a unit of measurement used to describe the percentage change in a financial instrument, such as a bond or interest rate.  One basis point is equal to one hundredth of a percent, or 0.01%.

For example, if an interest rate increases by 25 basis points (bps), it has increased by 0.25% (i.e. .01% * 25).  Similarly, if a bond yield decreases by 10 basis points (bps), it has decreased by 0.10%.

CONCLUSION:-

The Reserve Bank of Bank (RBI) as a regulatory authority reviews its decision on continuous basis to keep the reserves with a view to securing monetary stability in the country by taking proper measures including changes in Repo Rate & Reverse Repo Rate, keeping the main objective of country’s growth, in mind.