Repo rate or repurchase rate means where the commercial banks borrow money from the central bank (Reserve Bank of India) at a special rate to meet short-term fund requirements. They undertake government bonds as collateral to attain their fiscal goals, enabling liquidity regulation and control inflation.
The central bank lends money to banks for a short period against government securities. When there is a need for funds, RBI lends money to banks at that time also. This practice is generally followed, and the RBI procures bonds from commercial banks. The deal is to sell them back on a specific date.
For instance, if the central bank provides a repo rate at 5 % and the money borrowed by a commercial bank is Rs 100 crore, then the interest amount submitted to the central bank will be estimated at Rs 5 crore yearly basis.
It is primarily a deal for reacquiring wherein commercial banks provide securities like Treasury Bills to the central bank to receive short-term funds. The banks then reacquire those securities at a fixed price.
The Monetary policy committee (MPC) ascertains the repo rate, which the governor of RBI leadsI. According to the recent notification by the central bank, the current repo rate in India is 4% which was put in effect on May 22, 2020, while the reverse repo rate is 3.35%. There has been no change in these rates, as RBI decided in its meeting held on April 7, 2021.
Types of lending and borrowing under Repo Rate:
- Overnight Repo: It is a Repo exchange for a day. Banks sell securities to the central bank for money and acquire those the same day and submit the funds to the central bank for such kinds of deals.
- Reverse Repo Rate: It refers to the rate at which the banks lend money to the central bank in the short term. It maintains equilibrium in the market by placing repo rate and reverse repo rate.
- Term Repo: It comprises a period of over one day. The general duration of term repo or variable rate term repo is 7 days, 14 days and 28 days. The central bank usually issues the term repo auction as and when there is a requirement of funds by the banks for some time off over a day.
In the case of a rise in Repo Rate
- When there is an increase in the inflation rate in the economy, and according to the RBI, the situation may escalate to the next level.
- Repo Rate rises when there is a threat of depreciation of the currency.
- In the case of need of lowering any speculations that come out in fields such as foreign exchange.
- When the idea of setting up an asset arises as a consequence of redundancy of capital formation.
In case of a decrease in Repo Rate
- In a situation of a decrease in Repo Rate, the central bank considers both inflation and the fiscal deficit are appropriately monitored. There is an indication that demand caused a price increase will be noticed over time.
- When the economy indicates a decline, the Reserve Bank of India plans to grow the economy by paving the way for a friendly monetary policy.
- If the scenario of a balance of payments is considered to be regular by the central bank.