The repo rate in India

On May 4, the Reserve Bank of India, in a surprise move raises the “policy repo rate by 40 basis points to 4.40%, with immediate effect”.

What is the repo rate?

1. Instrument for monetary policy- The repo rate is one of several direct and indirect instruments that are used by the RBI for implementing monetary policy.
2. Overnight liquidity to banks -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).
3. Benchmark for the lenders -Since this is the rate of interest that the RBI charges commercial banks such as State Bank of India and ICICI Bank when it lends them money, it serves as a key benchmark for the lenders to in turn price the loans they offer to their borrowers.

How does the repo rate work?

1. Monetary Tool- Besides the direct loan pricing relationship, the repo rate functions as a monetary tool by helping to regulate the availability of liquidity or funds in the banking system.
2. Impact on money supply- 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.
3. Targets Inflation control -Since inflation is, in large measure, caused by more money chasing the same quantity of goods and services available in an economy, central banks tend to target regulation of money supply as a means to slow infl