What is repo rate and reverse repo rate

Do you know how different interest rates affect the economy, or why certain financial news makes it into the media? If yes, then you definitely must have come across the terms repo rate and reverse repo rate. Interest rates are one of the most important items for the economy, dictating money flow between the individual, business, and the financial institutions. Central banks use repo and reverse repo to check liquidity, control inflation, and maintain economic stability, as in the Reserve Bank of India (RBI). Let’s put them into the simplest of words!

The repo rate determines at which price the banks raise money from the central bank and thereby charge their customers their home or car loans as an interest rate. A higher repo rate, therefore, reduces borrowing and subsequently lowers inflation, whereas a lower one stimulates borrowing and economic growth.

Now, let us flip the scenario around. If the banks have excess cash that isn't required anytime soon, they will deposit it with the RBI so that they earn interest on their cash. To repay the banks, RBI charges interest. That rate of interest is termed as the reverse repo rate.

Put it this way: Whenever you have savings, you put it in a savings account where you get interest. Similarly, surplus funds of commercial banks are also invested with the RBI at reverse repo rate.

The reverse repo rate also fairly controls the money liquidity in the economy.

Repo rate and reverse repo rate are always working in tandem on both sides. This controls the money flow of the economy with the help of the working combination as follows:

The RBI hikes both the repo rate and reverse repo rate if its case is inflationary because of increase in inflation. The bank does not allow the surplus money deposited with RBI to be withdrawn because money is now costly. It signals that currently, there is less money in the market.

In order to promote growth in times of low growth, the RBI reduces its repo rate. This is because lending to individuals and business concerns in the economy has become cheaper for banks. Banks increase lending, and this goes ahead to increase the liquidity in the economy.

Knowing the difference between the repo rate and the reverse repo rate will further enable you to know how the RBI controls both growth and inflation.

Your hard-earned money is also impacted by the repo rate and reverse repo rate, in addition to the banks. One of the best illustrations of how repo rates can be utilised to support the economy during difficult times was these changes.

a) Loan Interest Rates:

Higher repo rates usually culminate in high interest rates for loans from banks. That is, paying a much higher price for your home, car, or your personal loan. Lower repo rates translate into cheaper loans.

b) Fixed Deposit Rates:

Rising repo rates typically mean more interest paid on fixed deposits as banks obtain better returns on excess funds parked with the RBI.

Knowing what the repo rate is and what the reverse repo rate is will help you better forecast changes in loan EMIs and deposit returns.

During its bi-monthly monetary policy reviews, the RBI revisits the repo rate and reverse repo rate. These reflect the macroeconomic conditions; it is a subliminal message whether inflation has to be checked or growth needs to be expedited.

For instance, during the COVID-19 pandemic, the RBI cut the repo rate to make loans cheaper and boost economic activities. These are some of the best repo rate changes that exemplify the usage of the aspect for the advantage of the economy during hard times.

Knowing the repo rate and reverse repo rate is what enables one to make an informed decision over their finances.

Therefore, in short, this repo rate and reverse repo rate is a tool used by the central bank to manage the money flow of the economy. The repo rate determines the cost of borrowing for banks. On the other hand, the reverse repo rate would influence the way banks would handle their excess funds. On balance, they keep inflation at acceptable levels and ensure economic growth.

The next time you hear about a change in the RBI's monetary policy due to an alteration in the rates, try to visualise how this might affect your financial plans. From repo rate to reverse repo rate, all such knowledge was previously only for economists, but it indeed impacts each and every one of us!