Union Budget 2019: Repo rate is RBI's mechanism to tame inflation, pump funds into economy to spur growth

FP Research

One may frequently come across the term "repo rate" while browsing through news. Often used in the context of monetary policy, the repo rate is the rate at which the central bank, the Reserve Bank of India (RBI), lends money to commercial banks.

Just like the common man pays interest on a loan borrowed from the bank, repo rate, simply put is the interest rate on the loan taken from the RBI. Banks often borrow from the RBI during a credit crunch and repay in a stipulated period of time.

Repo is also called repurchase option, wherein banks provide securities like T-bills to the RBI in exchange for a one-day or overnight loans. An agreement to buy these securities back at pre-determined rates will also be in place. Usually, banks repay these loans within a day and get back the T-bills which are kept as collaterals.

The repo rate, however, is also used as a key tool to check on the money flow, inflation rate and liquidity in the banking system. Notably, the higher the repo rate, the higher will be the cost of borrowing for banks and vice-versa.

When there is high inflation in the market, the RBI increases the repo rate, which makes borrowing costly. Consequently, investment slows down and it negatively impacts the economy. However, such action also reduces inflation.

On the other hand, if the RBI wants to pump more funds into the economy, it will reduce the repo rate. This will make borrowing attractive to businesses and spur growth in the economy.

The RBI changes the repo rate keeping the macro-economic scenario in mind. Any change, decrease or increase in rates, impacts the economy.

At present, the repo rate is at 5.75 percent, down 25 basis points from the earlier six percent. This is the lowest rate in the last nine years€"an attempt at boosting the struggling economy.

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