Repo rate is a powerful tool used by India’s central bank, the Reserve Bank of India (RBI), to maintain liquidity in the market and manage cash flow. The Monetary Policy Committee (MPC) of the RBI convenes bi-monthly to make changes to the repo rate according to economic conditions. It can be used to combat inflation, recession, induce cash flow, increase investment, etc. A hike or slash in the repo rate can have significant impacts on the economy, particularly the cost of borrowing credits. Thus, you must be aware of this term and what it implies for you as the borrower.
The repo rate is the rate at which commercial banks borrow from the RBI by selling security such as Treasury Bills to the central bank. Just like you, the borrower, borrow money from the bank by providing collateral and repaying the amount with an interest rate, commercial banks can also borrow money from the RBI in case of a cash crunch.
Here, the collateral is the Treasury Bills that commercial banks sell to the RBI, and the interest rate of borrowing is called the Repo Rate. However, the repo rate does not just affect the borrowing banks; it also affects the ordinary citizens of society.
The repo rate is the interest rate at which the Reserve Bank of India (RBI) lends short-term funds to commercial banks against government securities. When banks need to borrow money, they sell securities to the RBI with an agreement to repurchase them later at a slightly higher price. The difference in price reflects the repo rate. A lower repo rate makes borrowing cheaper, encouraging spending and investment, while a higher rate makes borrowing more expensive, helping to control inflation and slow down economic activity.
The repo rate is a highly crucial concept in economics and finance. Countless central banks and financial institutions use it to achieve specific macroeconomic objectives. These include:
During periods of high inflation, central banks often raise repo rates. This makes borrowing funds more expensive which can then reduce inflation.
Repo rate can also be used during periods of low economic growth. During this time, central banks may lower the repo rate, making borrowing funds easier.
Another primary function of the repo rate is managing liquidity within the banking system. Central banks achieve this by adjusting the repo rate, which controls how much money banks can borrow.
The RBI calculates the repo rate based on several factors. These include inflation, economic growth, and other economic conditions. Some central aspects include:
Banks often lower the repo rate to encourage borrowing and stimulate economic growth. This keeps the banking system balanced and ensures economic stability in the country.
The RBI increases the repo rate during periods of high inflation. Conversely, during periods of low inflation and economic stagnancy, it reduces the repo rate.
Other factors, such as banking requirements, international market fluctuations, and commodity prices, also play a role.
Changes in the repo rate can affect several areas of a country’s economy. These include:
Inflation is often controlled by changing the repo rate. For example, during periods of high inflation, the RBI will increase the repo rate, making it more challenging to borrow funds, thereby reducing money supply and inflation.
Adjusting the repo rate also often controls loan interest rates, which impacts the cost of personal loans, business loans, and mortgages.
Higher repo rates can increase national currency value.
The RBI’s repo rate can also impact consumer interest rates. It is essential to understand these effects for proper financial planning and decision-making:
A lower repo rate reduces banks' cost of borrowing funds, which often translates to lower interest rates on loans and credit for consumers and businesses. This can encourage borrowing and spending, boosting economic activity.
Banks may also lower deposit interest rates in response to a lower repo rate, as this reduces their cost of borrowing. This can impact a consumer’s returns on savings.
A higher repo rate increases borrowing costs, leading to higher interest rates on loans and credit. This means consumers must pay higher interest on loans, mortgages, and more. This can reduce borrowing and spending, helping control inflation by cooling down economic activity.
The relationship between the repo rate paid by the bank to RBI and the interest rates paid by the borrower to the bank is directly proportional. The greater the repo rate, the higher will be the cost of borrowing. Let us understand this with two examples.
As of December 2020, the repo rate was 4%. Suppose that RBI increases this to 6%. This means that now, the cost of borrowing from the RBI has increased by 2% or 200 basis points for commercial banks. To compensate for a high cost of borrowing, banks will, in turn, charge a higher interest rate from their borrowers. As a result, loans will become expensive for citizens.
Alternatively, if the RBI slashes this rate from 4% to 3.75%, banks will be able to afford borrowing more easily than before. They will reduce the interest rates for loans and taking a loan from the bank will become cheaper for citizens.
In addition to affecting the interest rates on loan, the repo rate also impacts the returns on direct deposits. If there is a repo rate cut, you will earn a lower interest rate and vice versa.
Additional Read: How a change in repo rate impacts your loan EMIs
Whether you are an investor, consumer, or business owner, understanding how the repo rate works is crucial. Understanding the impact repo rates have on interest rates, economic growth, and inflation can allow you to make better, more informed financial decisions.
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An increase in the repo rate usually leads to higher interest rates on loans. For existing borrowers with floating-rate loans, this means higher monthly EMIs or longer loan tenure.
A high repo rate can result in increased interest rates on credit cards. Banks may raise these rates to compensate for the higher cost of borrowing from the RBI, making credit card debt more expensive for consumers.
A reduced repo rate lowers the cost for banks to borrow from the RBI. This often leads to a decrease in interest rates on loans, making borrowing cheaper for consumers.
The difference between the repo rate and the reverse repo rate is called the interest rate corridor.
The repo rate is the rate at which the RBI lends money to commercial banks, while the MCLR (Marginal Cost of Funds Based Lending Rate) is the minimum interest rate that a bank can offer for loans.
The current repo rate is 6.00%. The Monetary Policy Committee recently lowered it by 25 points from 6.25%.
CRR (Cash Reserve Ratio) is the percentage of deposits banks must keep with the RBI. SLR (Statutory Liquidity Ratio) is the percentage of deposits commercial banks maintain through cash, gold, or other securities.
Repo rate stands for Repurchase Agreement Rate or Repurchase Option Rate. It refers to the rate at which the RBI lends funds to commercial banks.
A lower repo rate is generally considered positive for the stock market. This is because it reduces businesses' borrowing costs.
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28 April 2025
7 mins read
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