Monetary policy tools like the repo rate and reverse repo rate by the RBI lead to seamless management and functioning of a country’s economy and financial markets. Several factors of the economy, like money flow, inflation, currency exchange rates and overall growth rate, are sensitive to changes in these rates.
Learn more about repo and reverse repo rates in India and how they impact the overall economic situation.
The Reserve Bank of India (RBI) sets the Repo Rate, which stands for Repurchasing Option or Repurchasing Agreement. As per the repo rate definition, it is the rate at which commercial banks borrow funds from the RBI against the collateral of securities.
Banks borrow money from the RBI when they are short on funds or need funds to maintain liquidity in volatile market situations. In its recent Monetary Policy Committee review of December 2023, RBI kept the repo rate unchanged at 6.50%.
For borrowers, the most direct impact of a change in repo rate is the direct effect on the cost of borrowing. So, if the rate increases, the cost will too and vice-versa. A rise in the rate makes it challenging and costly for commercial banks to obtain funds from the RBI, so they offer loans at higher interest rates. Likewise, you get loans at affordable rates if the RBI lowers the repo rate.
Also Read: What is Cash Reserve Ratio Rate?
The repo rate is one of the most important tools the RBI uses to maintain price stability and control money flow in India’s economy. When the inflation rate increases, the RBI raises the repo rate to increase the borrowing cost and retain the cash flow in the economy.
As banks reduce their lending activities, the overall supply of money in the economy decreases. This reduced money supply leads to a decline in consumer spending, demand and investment, leading to price stability and controlled inflation.
The reverse repo rate by the RBI is another monetary policy instrument used to control the money supply in the market. It is the rate at which the RBI borrows money from banks within the country. Most commercial banks prefer the safer option of parking their funds with the RBI.
An increase in the reverse repo rate by the RBI means that commercial banks will get more incentives for parking their funds at the Central Bank. This, in turn, will lead to a decline in the money supply and availability of loans. The current reverse repo rate in India is 3.35%. Note that the reverse repo rate always remains lower than the repo rate.
Check the following table to know the differences between repo and reverse repo rates in India:
| Parameter | Repo Rate | Reverse Repo Rate |
|---|---|---|
| Lender and Borrower | The RBI lends the money to commercial banks | The RBI borrows money from commercial banks |
| Operational Mechanism | Banks offer their securities as collateral to gain funds and buy them back | The RBI pledges its securities to deposit funds and get loans |
| Objective | To promote price stability and money deficiency | To control the availability of money |
| Impact of Rate Hike | A hike in repo rate discourages banks from borrowing. As the repo rate rises, the interest rate increases, too | Banks prefer to deposit surplus funds with the RBI to earn interest, leading to a fall in the money supply |
| Impact of Decrease in Rate | Lower repo rates encourage lending with lower interest rates | Banks reduce deposits with the RBI and lend more to the public |
As mentioned above, an upward repo rate can increase your loan interest rates and an increase in the reverse repo rate can impact its availability. Such changes can impact your capability to receive desired loan amounts. With Fibe, you can get an Personal Loan of up to ₹5 lakhs online via an easy application process. You only need to meet basic eligibility and document requirements to get the required funds affordably.
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As of December 2023, the repo rate in India is 6.50%. The repo rate directly impacts the interest rates on loans, as it increases with a rise in the repo rate.
The Reserve Bank of India sets the reverse repo rate in the country. The reverse repo rate by the RBI is a monetary policy instrument to control the money supply.
The current repo rate is 6.50%. So, if a commercial bank borrows ₹1 lakh from the RBI, it will have to pay an interest of ₹6,500.
While the repo rate may affect borrowing costs, it is an essential tool to control the money supply and promote price stability in the economy.
