Know the Meaning of Repo Rate and Its Effect on the Indian Economy

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The Reserve Bank of India decreased the repo rate by 25 basis points on 4th October 2019, from 5.75% to 5.15%. It was the fifth meltdown in the rate by RBI in 2019 to revive the waning economy.

On 7th February 2019, the rate stood at 6.25%, which was slashed down to 6.0% on 4th April. It was the first in a series of this rate curtailment. This measure is taken by the RBI to address the lack of demand currently prevalent amongst consumers.

What is Repo Rate?

Repo is a portmanteau of “repurchasing option”. It can be considered as a contract, wherein financial institutions are obligated to offer RBI-recognised securities such as treasury bills to the Reserve Bank of India in exchange for overnight credit to meet any short-term financial deficit.

Such credit should be repaid by the respective financial institution within a short period by paying the loan amount along with interest and reclaim such provided security. Such interest rate, in this case, is known as the repo rate.

It is factored in along with the original loan amount to determine the repurchase value of the security in question.

The relationship between the Reserve Bank of India and other financial institutions is similar to that of the latter with their consumers.

Consequentially, RBI also facilitates the option of parking excess funds to other financial institutions, much like individuals depositing savings with financial institutions. RBI, in return, allows interest on such savings, in the form of reverse repo rate. In general, the reverse repo rate is lower than the repo rate.

Both the repo rate and reverse repo rate can significantly affect the macroeconomy of a nation. Let’s consider what to expect from the recent announcements on the repo rate cut by RBI.

How Does the Repo Rate Affect the Economy?

The current repo rate of any economy influences the interest rate at which lending institutions lend money to their customers. It is a decisive instrument at the disposal of the RBI, which allows it to curb any economic crisis by regulating inflation, money supply, and liquidity.

How this monetary policy affects the economy is discussed below –

Inflation

In the case of burgeoning inflation, the RBI shall announce a higher repo rate; this will, in turn, increase the cost of borrowing for other financial institutions. These lenders in question will consequently increase the rates of interest they levy on loans such as home loans.

A higher rate of interest subsequently discourages loaning by entities. It mitigates investment and money supply in an economy and allows RBI to constrict inflation.

Conversely, when there is an economic slump which results in slow inflation or deflation, RBI shall lower the repo rate, thus influencing financial institutions to decrease their MCLR and prevalence rates of interest. This measure encourages entities to avail loans to improve investment, production, and purchasing power of individuals.

Cash flow

Repo rate can also be used to restrict cash flow or allow greater cash flow. It follows the same rule, wherein an increase in this rate will influence lending institutions to increase MCLR, which cuts down the cash flow of the economy. Conversely, a lower repo rate allows lenders to provide loans at affordable interest rates, thus allowing greater cash flow.

The current repo rate of 5.15% is suggestive of lower interest rates on loans. Thereby, you can avail Home Loans at competitive interest rates from reputed financial institutions such as Bajaj Finserv.

While the RBI is attempting to improve the economic condition by allowing lower repo rates, the Government of India is also taking measures to mitigate poor demand. The Finance Ministry recently announced an injection of Rs. 70,000 Crore to several financial institutions to facilitate lending at a lower rate of interest.

It has also introduced schemes such as PMAY, under which, first-time homebuyers can avail subsidy on their interest payment of home loans. You need to know about your PMAY eligibility criteria before applying for the scheme.

While the repo rate is an effective instrument that concerns itself with the macroeconomic condition of India, it does not directly influence the micro economy.

Ergo, a guide to getting better home loan interest rates will allow you to consider factors that can improve your chances of attracting competitive rates of interest.

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