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- Recently, analysts expect the RBI to hike repo rates against the backdrop of high retail inflation.
About Repo rate
- Meaning
- The repo rate is one of several direct and indirect instruments that are used by the RBI for implementing 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 place government securities that they hold with the central bank and borrow money against these securities at the repo rate.
- Why is the repo rate such a crucial monetary tool?
- When government central banks repurchase securities from commercial lenders, they do so at a discounted rate that is 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 the repo rate work?
- Besides the direct loan pricing relationship, the repo rate also functions as a monetary tool by helping to regulate the availability of liquidity or funds in the banking system.
- For instance, when the repo rate is decreased, banks may find an incentive to sell securities back to the government in return for cash.
- This increases the money supply available to the general economy.
- Conversely, when the repo rate is increased, lenders would end up thinking twice before borrowing from the central bank at the repo window thus, reducing the availability of money supply in the economy.
- What impact can a repo rate change have on inflation?
- Changes to the repo rate to influence interest rates and the availability of money supply primarily work only on the demand side by making credit more expensive and savings more attractive and therefore dissuading consumption.
Source: TH
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