repo rate in india

the story So Far: On May 4, the Reserve Bank of India, in a surprise move, announced that the bank’s Monetary Policy Committee (MPC) had held an ‘off-cycle’ meeting, in which it unanimously decided to raise the “policy repo rate by 40 basis points”. Was. 4.40% mark with immediate effect.” Amid geopolitical tensions, citing ‘inflation which was alarmingly rising and spreading rapidly’ globally, RBI Governor Shaktikanta Das said the MPC decided to was that the ‘inflation outlook necessitated a proper and timely response through firm and calibrated steps to ensure a second round. The effects of supply-side shocks on the economy were contained and long-term inflation expectations were firmly placed’ ‘. Mr Das said the monetary policy response of the RBI will help in maintaining macro-financial stability amid rising volatility in financial markets.

What is Repo Rate?

Repo rate is one of the many direct and indirect instruments used by RBI to implement monetary policy. Specifically, the RBI defines the repo rate as the fixed interest rate at which it provides overnight liquidity to banks against the collateral of government and other approved securities under the Liquidity Adjustment Facility (LAF).

In other words, when banks have short-term requirements for funds, they can keep government securities with the central bank and borrow money against these securities at the repo rate.

Since it is the rate of interest that RBI charges to commercial banks such as State Bank of India and ICICI Bank when it lends money to them, it acts as an important benchmark for lenders, in turn, to their borrowers. The value of the loan given to.

Why is the repo rate such an important monetary tool?

According to Investopedia, when state-run central banks repurchase securities from commercial lenders, they do so at a discounted rate known as the repo rate. The repo rate system allows central banks to control the money supply within economies by increasing or decreasing the availability of funds.

How does repo rate work?

Apart from the direct loan pricing relationship, the repo rate also acts as a monetary tool by helping to regulate the liquidity or availability of funds in the banking system. For example, when the repo rate is reduced, banks may have an incentive to sell back securities to the government in exchange for cash. This increases the money supply available to the general economy. Conversely, when there is an increase in the repo rate, lenders will think twice before borrowing from the central bank over the repo window, which will reduce the availability of money supply in the economy.

Since inflation is, largely, caused by more money chasing the same amount of goods and services available in an economy, central banks target regulation of the money supply as a means of slowing inflation.

What is the impact of change in repo rate on inflation?

Inflation can be broadly: a price advantage driven primarily by demand, or the result of supply-side factors that in turn increase the cost of inputs used by producers of goods and providers of services, thus driving inflation. is, or is often caused by, a combination of both demand and supply side pressures.

Changes in the repo rate to affect interest rates and the availability of money supply mainly work only on the demand side by making credit more expensive and saving more attractive and hence reducing consumption. However, they do little to address supply-side factors, be it the higher prices of commodities such as crude oil or metals, or imported foodstuffs such as edible oil.

What other factors affect the effectiveness of the repo rate?

There is also another aspect to consider. The increase in the repo rate affects the real economy.

In February 2021, the RBI in its annual ‘Report on Currency and Finance’ stated that the “challenge to an efficient operating process” [of monetary policy] The policy rate change aims to narrow the transmission gap from the operating target”, which in this case is mandated to hold medium-term inflation at 4% and bound within a tolerance range of 2% to 6%.

RBI mentioned in the report that there were multiple channels of transmission, ‘interest rate channel; credit or bank lending channel; exchange rate channels driven by relative prices of tradable and non-tradable goods; asset value channel affecting the money/income earned from the holding of financial assets; And the Expectations channel captures the perceptions of households and businesses on the state of the economy and its outlook.

“These channels of transmission are interconnected and work in conjunction and are difficult to isolate,” the central bank said, adding that monetary authorities face challenges in ensuring that changes in the repo rate are realistic. helps in achieving the objective of the policy.