On October 4 this year, the Reserve Bank of India (RBI) slashed its key repo rate by 25 bps. For keen followers of the Indian economy, the current repo rate cut is a thing of particular interest. It is the fifth time this year that the RBI has decreased its repo rate, for a cumulative cut of 135 bps within the year 2019.
So for those uninitiated with the process, it is natural to wonder whether this is a common occurrence or not. Does the RBI introduce repo rate cuts every year and if so, what is their purpose? Let us take you through some key points:
What is repo rate?
Just as an average citizen can avail a loan from a lender at an interest rate, banks themselves also avail loans from the Government of India via the RBI. The repo rate, also known as repurchase rate or key short term lending rate, is the rate at which the RBI lends money to commercial banks in India to help them meet their financial requirements. If banks are running low on funds, they can avail short term loans from the RBI, with 1 day maturity, at the repo rate that is set at the given time.
Until the year 2016, repo rates and the decision to increase or decrease them was conducted by the RBI governor, after consulting his committee of financial advisors. Today, fiscal decisions such as repo rate cuts are made by a Monetary Policy Committee (MPC), consisting of three RBI officials and three government nominees. They make important decisions such as repo rate cuts after three days of consideration and on the basis of factors such as current state of the economy, inflation, fiscal deficit and fiscal projections. The repo rate cuts
Why are repo rates changed and how often?
Keep in mind that repo rates are ultimately determined by the RBI, based on the various tasks that it is expected to fulfill every year. Apart from being a prudent banker to both the government and the commercial banks, the objectives of the RBI are to maintain a healthy economy, to facilitate economic growth and to predict and avoid fiscal pitfalls such as inflation.
This is why repo rates act as one of the RBI’s most effective tools. Higher repo rates imply that loans to commercial banks become more expensive, while lower repo rates make loans cheaper and therefore, more attractive to commercial banks.
Source: Paisa Bazaar
At any time when the Reserve Bank of India judges it important to stimulate economic growth, it lowers the repo rate to encourage banks to avail large loans. This, in turn, has an impact on every sector of the economy, particularly on the average borrower. Since banks are able to borrow money from RBI at lower interest rates, they are thereby able to offer loans and other banking products to borrowers at lower rates as well.
With cheaper bank loans, consumers are able to borrow more and therefore purchase more, therefore leading to a boost in the economy. Hence, the lower the repo rate, the higher the liquidity ie. the amount of money that is put into circulation in the economy. This helps stimulate widespread growth in the economy of the country.
On the other hand, increased liquidity in the economy can lead to inflation and raise the prices of services and products. In such a case, the RBI increases the repo rate to control inflation by making loans more expensive to banks and reduce the supply of money in the economy.
Therefore, how often the RBI deems it necessary to increase or decrease the repo rate largely depends on where the economy is heading at the time. In the past, the RBI has been able to avoid widespread impacts of inflation by raising the repo rate. On the other hand, such as in recent years, it has sought to boost economic growth and increase the country’s gross domestic product percentage by drastically lowering the repo rate.
In trying to make ends meet, it is hard for the average consumer to be able to foresee where the economy might be headed next. Therefore, whether the repo rates rise or fall, it is important to have the support of a trusted lender to ensure one’s financial needs are always met and our future is safeguarded.
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You can also read about impact of GST on Personal Loan.
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