What is the Repo rate?

The repo rate may be termed as the discount rate at which a central bank repurchases government securities from the commercial banks that largely depends on the level of money supply it decides to maintain in the country's monetary system. It is when banks have any shortage of funds they borrow it from the central bank. Any reduction in repo rate helps the bank to avail funds at cheaper rates. An increase in repo rate, on the other hand, curtails the borrowing power of banks as borrowing becomes quite expensive.

This central bank acts as a banker for private banks. The last destination of banks when they fall short of cash or need liquidity on a regular basis is the central bank. The repo rate system works on the temporary sale of financial asset by the bank in return for the needed cash from the lender. Thus, borrowing and lending works largely on the policy of give and take.

It is when repo rate increases banks have to pay more for repo funds. Thus, for maintaining their existing profit they raise the interest rates and charge high rate of interest from their customers to balance the profit margin. This in turn, facilitates a rise in the interest rate and helps to control inflation by reducing the demand for the credit which could be spent on the purchase of goods and services. Thus, repo rate not only serves as a benchmark for the level of short-term interest but also for deciding and balancing inflation.

In order to tame inflation, banks sell their securities at a discount price called repo rate. They sell their securities like treasury bills for a limited short period of time. Banks are eligible for repurchasing the bill at its face value after specified amount of time. Therefore, high repo rate absorb the liquidity from the bank to lend more money to the customers and thus it helps to stabilize the rising inflation.

Repo rate is determined at each meeting by the bank of its Monetary Policy Committee which is generally known as the formulation and implementation of monetary policy. Monetary policy is conducted with the objective of targeting inflation.

At the time of setting monetary policy the Bank decides and focuses on the short-term interest rates which are all the more necessary to meet the inflation target. The Monetary Policy Committee of the Bank is looking after a range of economic factors with domestic and internationally that has a bearing on future inflation. The demand for the money, overall lending policies of the banks, and credit in the economy is influenced by the monetary policy committee decisions. If the MPC indicates that with an unchanged repo rate inflation decline, the committee will reduce the repo rate, and if committee indicates that with an unchanged repo rate inflation rise, it tends to rise.

Since the Central Bank efficiently permits repo rate to be transmitted to the economy, it plays an active and vital role in stimulating the development of the effective application of monetary policy measures which are the capital markets and relatively free and efficient money. At last, Repo rate cut will encourage the banks to prepare their deposits rates in advance, eventually bringing down the cost of funds.