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Behind RBI’s repo rate pause

  • Published
    7th Apr, 2023
Context

The pause in the rate hike cycle by the Reserve Bank of India (RBI) is now being seen as a favourable step to make the growth-inflation trade-off lean more in favour of the growth, especially in the backdrop of emerging concerns over slowing consumption.

About the move:
  • The recent pause in the rate hike is necessary as a high base effect during March-October was expected to ease pressure on the headline retail inflation rate.
  • The moderation in inflation rate forecast for FY24 to 5.2 per cent from 5.3 per cent earlier has imparted some breathing space to the RBI to pause its rate hike cycle.
  • The move is seen significant, as there are lingering concerns over the entrenched and high core inflation – the non-food, non-fuel component of inflation.
  • The RBI also outlined risks from protracted geopolitical tensions, tight global financial conditions and global financial market volatility to its monetary policy outlook.
  • Global financial market volatility has surged, with potential upsides for imported inflation risks.

What is Repo rate?

  • Repo stands for “Re Purchase Option”. Repo Rate is the rate at which the central bank (Reserve Bank of India) lends to other banks by buying the securities with an agreement that the bank will buy back on a certain date.
  • Repo lending is a short-term lending option to meet the liquidity requirements of commercial banks.
  • Repo rate is the rate at which the Reserve Bank of India (RBI) lends to other banks.
  • It is a part of the Liquidity Adjustment Facility (LAF) of the RBI.

Components of Repo Rate:

  • Preventing "squeeze" in the economy - The central bank adjusts the Repo rate in response to inflation. As a result, it seeks to govern the economy by keeping inflation under control.
  • Hedging and Leverage - The RBI tries to hedge and leverage by purchasing securities and bonds from banks and providing cash in exchange for collateral deposited.
  • Short-Term Borrowing — The RBI lends money for a short length of time, up to an overnight period, after which banks purchase back their deposited securities at a predetermined price.
  • Collateral and Securities — The RBI takes gold, bonds, and other forms of collateral.
  • Cash Reserve or Liquidity: Banks borrow money from the Reserve Bank of India (RBI) to preserve liquidity or cash reserves as a precautionary measure.

Impacts of repo rate:

  • The increased repo rate will discourage banks to borrow from the RBI and lending to the customers.
  • This in turn will reduce the liquidity and demand in the market.
  • It is part of the contractionary monetary policy.
  • On the other hand, decreased repo rate will encourage banks to borrow and lend to customers increasing the liquidity and demand in the market. This is a part of the Expansionary Monetary Policy.

Bank rate Vs. Repo rate:

Parameter

Bank Rate

Repo Rate

Meaning

The Bank Rate is applied to loans made by the central bank to commercial banks.

Repo Rate is applied to the central bank's repurchase of securities sold by commercial banks.

Collateral

No collateral is required

Securities, bonds and agreements are given as collateral

Impact

Directly impact customers as it impacts long term lending.

The Repo rate is handled by the banks and doesn’t impact the customers directly.

Rate

Higher than Repo due to no collateral and long term nature.

Lower than Bank Rate as there is a collateral and repurchase obligation.

Duration of loan

Bank rate caters to long term requirements of commercial banks.

Repo Rate focuses on short term financial lending.

 

 

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