What are Repo and Reverse Repo Rates, Know Complete Details

What is RBI’s Monetary Policy and Repo Rate?

You might have heard that the Reserve Bank of India (RBI) sometimes increases or decreases the “repo rate.” This decision directly affects things like inflation (how fast prices are going up) and the interest rates for bank loans. The policy behind these decisions is called the Monetary Policy, and it’s a powerful tool that the RBI uses to control the economy and keep prices stable.

Why Can’t RBI Just Print More Money?

We often wonder why the RBI doesn’t just print enough money to eliminate poverty in India. While it might sound like a simple solution, printing excessive amounts of money would actually create severe problems. If the RBI printed too much currency, prices would skyrocket, causing inflation and decreasing the money’s value, resulting in economic chaos. Instead of this approach, the RBI uses Monetary Policy to regulate the money supply in the economy, ensuring stability and managing inflation effectively.

How Do Banks Work with RBI?

When we need a loan, we go to a bank like SBI or PNB. But when banks need money, they go to the RBI, which is why it’s called the “bank of banks.” The RBI controls how much money banks can borrow and at what interest rate, which is called the “repo rate.”

What is the Repo Rate?

The repo rate is the interest rate at which the RBI lends money to banks. Think of it as the price banks have to pay to borrow money from the RBI. For example, if the repo rate is 5%, then banks will be charged 5% interest when they borrow money. To make a profit, banks will lend that money to us at a higher rate, like 10%.

Why Does the Repo Rate Matter?

The repo rate affects how much it costs to borrow money. When the repo rate goes up, banks have to charge higher interest rates to their customers, making loans more expensive. This means people are less likely to borrow money, so they spend less. With less money being spent, sellers may lower their prices to attract customers, which helps bring down inflation.

On the other hand, when the repo rate goes down, loans become cheaper. This encourages people to borrow and spend more, which can help boost the economy, especially during tough times like the COVID-19 pandemic.

How Does This Control Inflation?

When Prices Are Rising Too Fast (High Inflation): If inflation is getting out of hand, the RBI increases the repo rate. This makes borrowing money expensive, so people and businesses will take fewer loans, reducing spending. With less money being spent, sellers may lower their prices.

When the Economy Needs a Boost: If the economy is slow, the RBI can lower the repo rate. This makes loans cheaper, encouraging people to borrow and spend more, which can help businesses grow and the economy recover.

Repo Rate Range & Changes

The repo rate can vary between 2% and 14%, depending on how the economy is doing. The RBI adjusts it multiple times a year to keep the economy balanced.

Other Tools RBI Uses Along with the Repo Rate

Besides the repo rate, the RBI has other Monetary tools to control the economy:

Marginal Standing Facility (MSF): This facility allows banks to borrow money overnight from the RBI at a higher rate than the repo rate. It is intended for emergency situations where banks face a shortage of liquidity. the marginal standing facility (MSF) rate in India is 6.75% as of now.

Bank Rate: When banks need to borrow from the RBI for longer durations (beyond 14 days), the interest rate charged is known as the Bank Rate. This rate can change up to four times a year and reflects the cost of borrowing for banks in longer-term scenarios.

Reverse Repo Rate: When banks have excess funds, they can deposit this money with the RBI, which pays them interest at the reverse repo rate. This rate is always lower than the repo rate because the RBI is not in urgent need of funds. Currently the reverse repo rate is around 3.35%.

Cash Reserve Ratio (CRR): This is a percentage of a bank’s total deposits that must be kept with the RBI as a security measure. Currently, it is around 4.5%. Banks do not earn any interest on the CRR funds, making them effectively useless for lending or investment purposes.

Statutory Liquidity Ratio (SLR): In addition to the CRR, banks are required to maintain a certain percentage of their deposits (currently about 18%) in liquid assets such as cash, gold, or government securities. This ensures that banks do not lend out all of their funds and always have some liquidity available.

Open Market Operations (OMO): The RBI also conducts operations like buying or selling government securities in the open market to control liquidity. For instance, when there is excess liquidity, the RBI sells securities to absorb the excess cash, thus reducing the money supply in the market.

Conclusion

The RBI’s Monetary Policy, especially the repo rate, is crucial for controlling inflation and supporting economic growth. By changing the repo rate, the RBI can make borrowing money easier or harder, which helps keep the economy stable. Understanding this can help you see why these changes in the repo rate are important for everyone.