Repo Rate in India: Reverse Repo Rate & Current Repo Rate 2020

What is Repo Rate?

Repo rate is the rate at which reserve bank of India lends money to the commercial banks due to shortage of funds. This RBI tool is used by monetary authorities in order to control inflation.

How does Repo Rate work?

When a commercial bank borrows money from RBI, it needs to pay interest to the central bank (RBI) on the principal amount. It has been borrowed by the commercial bank at the time of shortage of funds. The interest rate charged by the RBI is known as repo rate.

In technical terms, Repo rate is basically stands for repurchase agreement. It is an agreement between RBI and the commercial banks in which commercial banks sell their securities to RBI in order to avail loan. An agreement has also been made to repurchase securities at a predetermined price. Hence, commercial banks get the money and central bank gets the security.

What are the components of Repo Rate Transaction?

Repo rate transactions are based on the parameters on the basis of which RBI agrees to execute the transactions with the commercial banks –

Inflation control – The central bank increases or decreases the repo rate on the basis of inflation. It is basically done by RBI to control inflation and to keep it in the limit.
Short-term borrowing – RBI lends money to the commercial banks for a short period of time against which the deposited securities later bought back by the banks which are earlier deposited at a predetermined price.
Hedging & leveraging - RBI aims to hedge & leverage by buying securities and bonds from the commercial banks and in return providing them cash.
Cash reserve on liquidity – Commercial banks borrow money from RBI in order to maintain the liquidity or cash reserve as a precautionary measure.
Collaterals & Securities – Reserve bank of India accepts securities or guarantees in the form of golds, bonds etc.

How does Repo Rate affect the economy?

Repo rate is an important RBI tool used to control inflation, money supply as well as to maintain liquidity in case of shortage of funds. The repo rate has a direct impact on the borrowing cost of banks. In case repo rate is high, the cost of borrowing for banks will also be high.

Increase in inflation – When there is an increase in the flow of money in the economy, RBI tries it’s best to bring it down. There are many way to control the high inflation level and one way of doing it is to increase the repo rate. It makes borrowing a costly affair for businesses and industries which results in slowing down of investment and money supply in the government. It negatively impacts the growth of the economy which helps in inflation control.
Increase in market liquidity – On the other side, when RBI needs to increase the flow of money into the system, it lowers the repo rate. Due to reduction in repo rate, it makes borrowing cheaper for businesses & industries for investment purposes. It helps in boosting the growth rate of the company.

Reverse Repo Rate

Reverse repo rate is a rate at which RBI borrows money from the commercial banks. It is lower than the repo rate. It is basically used to absorb the excess liquidity in the market. RBI increases the reverse repo rate at the time of high level inflation in the economy. Banks generally provide more funds to RBI in order to earn high returns on excess funds which makes commercial banks left with fewer funds to provide loans & borrowings to consumers.

Difference between Repo Rate and Reverse Repo Rate

There are many differences between repo rate and reverse repo rate and the same is specified in the table below –

Repo Rate	Reverse Repo Rate
It is the rate at which RBI sends money to the commercial banks	It is the rate at which RBI borrows money from the commercial banks
It is higher than the reverse repo rate	It is lower than the repo rate
The main purpose of repo rate is to control inflation and shortage of funds	Reverse repo rate is used to manage cash flow
It includes selling of securities which can be purchased again in future	It includes transferring of money from one account to another

Current Repo Rate

Modification of Repo rate impacts all sectors of the economy as a whole. As a result, some segments may result in gain whereas other suffers losses.

Any change in the repo rate can directly impact bug ticket loans such as home loans. The main purpose of decreasing the repo rate is to increase the growth and improve the economic development in the country. A decline in the repo rate will encourage consumers to buy more from banks which may results in stabilization of inflation. It is very beneficial for the retail loan borrowers.

RBI has recently reduced the current repo rate from 5.75% to 5.15% whereas reverse repo rate has been reduced from 5.5% to 4.9%.