Repo rate
Repo rate is the rate at
which a central bank in a country lends money to commercial banks in the event
of any shortfalls in funding. Monetary authorities use the repo-rate to monitor
inflation.
In the event of inflation,
central banks raise the repo rate as this serves as a disincentive
for bank borrow from central bank. This eventually decreases the
supply of money in the economy and therefore helps to stop inflation.
If the prices are high,
the supply of credit and demand decreases, resulting in a decline in inflation.
Repo rate is the rate at which RBI loans government securities
to its clients in general. Reduction in the repo rate allows commercial banks
to get money at a cheaper rate, and a rise in the repo rate discourages commercial
banks from getting money as the rate rises and becomes costly.
The rise in the repo rate would raise the borrowing and lending
costs of the banks, which will deter the public from borrowing money and allow
them to deposit.
The rise in the rate of repo and the cost of lending is a sign
of the tightening of the regime.
Reverse Repo Rate is when the RBI borrows money from banks when
the market has excess liquidity. The banks benefit from it by getting interest
with the central bank for their holdings.
Reverse Repo Rate is a mechanism for absorbing market liquidity
thus limiting investor borrowing power.
The RBI increases the reverse repo during high levels of
inflation in the economy. It encourages banks to park more RBI funds to earn
higher returns on over-funds. Banks have fewer funds left to distribute loans
and borrowings to customers.
Repo rate and Reverse Repo rate are the instruments of the
Monetary Policy.
Monetary policy is the macroeconomic approach set down by the central bank. Monetary
policy is the mechanism by which a central bank (RBI) controls the supply of
money in the economy.
Monetary Policy also includes the executives
of cash supply and interest rate and is the demand side financial arrangement
utilized by the administration of a nation to accomplish macroeconomic goals
like consumption, inflation, liquidity and growth.
In
India, monetary policy of the Reserve Bank of India is planned for dealing with
the amount of cash so as to meet the necessities of various parts of the
economy and to build the pace of monetary development.
On 31 December, 2019, Repo rate was 5.15% and Reverse Repo rate was
4.90%.
But the current situation is different and according to the
recent news that RBI has cut the repo rate by 40 bps and now
Repo rate is 4% and reverse repo rate is 3.35%.
For the second time this year, the Reserve Bank of India
(RBI) slashed its key policy repo rate at an emergency meeting on May 22 to
counter the economic impact of an ongoing nationwide lockdown to contain
coronavirus spread.
According to Rajnish
Kumar, Chairman, SBI & IBA, the
announcement of the RBI policy in response to the COVID pandemic crisis is
timely. Reducing the policy repo rate by 40 bps on the assumption that growth
would be negative in FY21 is a reasonable step to boost economic activity.
Pandemic-related volatility, normalization of economic
activity, and social-distance relaxation make it necessary to calibrate and
swift policy responses.
According to Sujan
Hajra, Chief Economist, Anand Rathi Securities, Mumbai, the 40-bps rate
cut is consistent with plans as is the extension of the loan moratorium. The
most significant announcement is the move to turn the moratorium interest
payment into a term loan due in the course of FY21.
This move can
reduce NPA, over the next 12 months at least. The more liquidity steps are also
quite muted. However, the RBI remains circumspect about the outlook for growth
and inflation.
According to Radhika Rao, Economist, DBS Bank, Singapore, the RBI has flagged the risks of
this year's negative growth print while holding off on a point goal. We expect
disinflationary factors to dominate, indicate we are open to more cuts.
Transmission should be closely
monitored with shorter tenor rates already well below the repo rate, given the
liquidity surplus conditions, with benchmark-linked lending rates expected to
drop along with savings rate changes.
According to Vikas Jain, Senior Research Analyst, Reliance
Securities, the
MPC's repo rate reduction is consistent with the recent economic data warranted
for an immediate reduction, but the extended 3-month moratorium poses some risk
of rising NPA's that have dragged the market momentum and banking stocks to
trade at day 's low.
Nifty has downside support levels of 8,950
and we expect the markets to be volatile next week with extended weekend and
rollover movements in individual sectors and stocks with respect to the expiry
of derivatives. We remain optimistic on the markets and a fall of close to
8,650-8800 rates is strong medium-term support.
Owing to changing macroeconomic factors RBI continues to adjust the repo rate and the reverse repo rate. Once RBI alters the prices, it affects all sectors of the economy, but in different ways. Some segments are gaining from the rate hike while others may be suffering losses.
A decline in the repo rate will result in banks lowering their lending rate. This can prove helpful to lenders on retail loans. However, the lender has to lower its base lending rate to carry down the loan EMIs. The RBI guidelines allow banks / financial institutions to pass the benefit of interest-rate cuts to customers as soon as possible.
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