Published on: December 9, 2022

Monetary Policy

Monetary Policy

Why in news?

The Reserve Bank of India (RBI) raised the policy repo rate by 35 basis points , downshifting gears from consecutive increases of 50 bps, and scaled down GDP growth hopes for the year to 6.8% from 7%, and exuded confidence about the economy being resilient and asserted that “the worst of inflation” was behind

Repo Rate

  • It is the interest rate at which RBI loans money to commercial banks.
  • Repo (Repurchase Agreement or Repurchasing Option), Banks obtain loans from the RBI by selling qualifying securities.

How Does Repo Rate Work?

  • The central bank or RBI and the commercial bank would reach an agreement to repurchase the securities at a set price.
  • When banks are short on funds or need to maintain liquidity under volatile market conditions, this is done.
  • The repo rate is utilized by the RBI to manage inflation

How it is used in managing inflation?

  • An increased repo rate means that banks borrowing money from the central bank during this period will have to pay more interest.
  • This inhibits banks from borrowing money, reducing the amount of money in the market and helping to negate inflation.
  • In the event of a recession, repo rates are also reduced.

What is Reverse Repo Rate?

  • As the name implies, reverse repo is the inverse contract to the repo rate.
  • The reverse repo rate is the rate at which the RBI borrows funds from the country’s commercial banks.
  • It is the rate where the commercial banks in India park excess funds with the Reserve Bank of India, typically for a short period of time.

Distinction Between Repo Rate and Reverse Repo Rate

Repo Rate Reverse Repo Rate
The lender is the RBI, and the borrower is the commercial bank.

The objective is to manage short deficiency of the funds.

The rate of interest for repo rates is higher than that of reverse repo rates.

The interest charge that is applicable to the repo rate is through a repurchase agreement.

The mechanism of operation in the case of repo rate for commercial banks gets funds from RBI utilizing government bonds as collateral.

Higher the rate, the cost of the funds in repo rate increases for commercial banks hence the loans become more expensive.

Lowering the rate makes the cost of the funds lower for commercial banks and leads to lower interest rates on loans.

The lender is the commercial banks, and the borrower is the RBI.

It is to reduce the overall supply flow of money in the economy

The rate of interest is lesser than the repo rate.

The applicable interest charge is through a reverse repurchase agreement.

In reverse repo rate, the commercial banks deposit their excess fundswith the RBI and get interest from the deposit.

When the rate is high, the money supply in the economy gets loweras commercial banks park more excess funds with the Reserve Bank of India.

When the rate is low, the money supply in the economy gets higheras banks lend more and lessen the deposits with RBI.