Effects of Increase or Decrease in Repo Rate

When individual borrowers borrow money from lenders, they pay interest on the principal amount. This interest is the lender’s payout for taking the risk and lending you money and is known as the Cost of Credit. Much like how individuals borrow money from commercial lenders, financial institutions, when they are short on cash, borrow money from the Reserve Bank of India. Financial institutions can borrow money by either pledging some government-recognized securities or without pledging any assets. 

When lenders borrow money without pledging any assets, the Reserve Bank of India charges interest in the form of the Bank Rate. However, when lenders borrow money from the RBI by pledging assets, the RBI charges a much lower rate of interest. This rate of interest that the RBI charges commercial lenders when they borrow money by pledging government-recognized assets, such as cash, gold, government-approved bonds, etc. is known as the Repo Rate. The Repo Rate is almost always lower than the Bank Rate. Lenders within the country borrow money at the Repo Rate when faced with liquidity issues. Repo refers to Repurchasing Option or Repurchase Agreement. Banks borrowing under the Repo Rate borrow under the condition that they will repurchase the securities they have pledged at a predetermined price before a designated date. 

The opposite of the Repo Rate is Reverse Repo Rate. Sometimes, banks have extra cash and therefore, they deposit this cash with the RBI and earn interest on it. The rate of interest at which RBI pays lenders interest on the deposits they have made with the central bank is known as the Reverse Repo Rate. The Reverse Repo Rate is also always lower than the Repo Rate. 

Currently, the Repo Rate stands at 6.50%, the Reverse Repo Rate is 3.35% and the Bank Rate is 6.75% per annum. 

Before we get into the details of how a Repo Rate hike or a Repo Rate reduction impacts the common borrower, let us look at why is the Repo Rate important and how the RBI use this monetary policy tool to its advantage. 

• The Repo Rate is an important monetary policy tool that the RBI uses to keep inflation under check. 
• The central bank of the country also uses this monetary policy tool to ensure stable economic growth. 
• Repo Rate also helps the RBI help banks and lenders remain liquid.

Let us now understand how any changes in Repo Rate affect the common borrower. 

What is the Effect of Increase or Decrease in Repo Rate?

When the inflation within the economy increases or if the RBI feels convinced that the inflation will increase in the days or months to come, the RBI increases the Repo Rate and Bank Rate or the rate at which the RBI lends money to commercial banks and lenders. When the RBI increases the Repo Rate, banks and lenders are compelled to borrow money at a higher rate of interest. Lenders pass on these higher interest rates to the common borrower. Thus, when the RBI increases the Repo Rate, the cost of borrowing increases and loans become expensive. 

Further, these days, most lenders offer Repo Rate-linked home loans. In the case of such home loans, EMIs go up every time the Repo Rate increases, which also increases the cost of borrowing the loan. 

Moreover, when the RBI increases the Repo Rate, borrowing money becomes expensive and therefore, individuals borrow only when they absolutely need it. This reduces the money supply within the economy. Moreover, this also reduces the common man’s purchasing power, which in turn, helps bring inflation under control. On the other hand, when the government wants to increase the supply of money within the economy, it decreases the Repo Rate. When the government decreases the Repo Rate, loans become cheaper. People borrow more and have higher purchasing power. This, in turn, increases the flow of money within the economy.

Read Also: What is the Difference Between Bank Rate and Repo Rate

Final Words 

In conclusion, the Repo Rate is an important monetary policy tool and individual borrowers must keep themselves informed about any changes in the Repo Rate as these changes have a direct impact on how borrowers borrow money and spend it.