Repo Rate is used as a primary tool in RBI’S monetary and credit policy . Repo rate is the rate of interest at which commercial banks borrow money from the central bank i.e. Reserve bank of India (RBI) against government securities. RBI generally lends money for short term to commercial banks to control credit availability, inflation and to maintain liquidity in the economy.
This rate is decided by The Monetary Policy Committee (MPC) along with the RBI governor who is the chairperson of the committee based on the inflation and fiscal projections.
HOW DOES REPO RATE WORKS ?
REPO basically stands for “Repurchasing option” or “Repurchase Agreement”. In this agreement banks avail overnight loans from Central Banks by providing them eligible securities like Treasury bills. Thus, the banks get the cash and central bank gets the securities.
When a person borrows money from the bank he has to pay interest on the principal amount at the time of repayment. Similarly, banks also have to pay interest to the Central banks on the money borrowed by them in case of shortage of funds . This interest rate is called repo rate.
IMPACT OF REPO RATE ON THE ECONOMY
- To control Inflation :- At the time of high inflation, RBI increases the repo rate. This increases the cost of borrowing for banks which in turn increases the bank rate also. Thus, it reduces the borrowing capacity of businesses and industries which slows down investments and supply of money in the economy. In this way situation of inflation is controlled.
- To increase the money supply in Economy :- RBI uses repo rate as a tool to increase flow of money in the economy by decreasing the repo rate. This reduces the cost of borrowing for both banks as well as businesses which will result in increasing investments and overall supply of money in the economy.
At present , the repo rate in India is 4.00%. Thus, in simple words, Repo rate is a significant rate set by RBI at which banks borrow short term money from central banks to meet their shortfall of funds and maintain their liquidity position. Everything from interest rates on loans to returns on deposits is influenced by this rate.