Explained: What is repo rate, reverse repo and monetary policy

The Reserve Bank of India released its monetary policy report on Friday and kept key lending rates – repo and reverse repo rates – unchanged at 4% and 3.35%, respectively. RBI Governor Shaktikanta Das said the six-member monetary policy committee had voted unanimously to leave rates unchanged and keep the central bank’s stance “accommodative”, meaning it remains conducive to easier borrowing between the RBI and other banks in the country.

LILY: RBI keeps policy rates at historic lows and raises inflation forecast

Das – who delivers the first monetary policy review of the 2022/23 financial year – also said India’s projected real GDP is expected to be 7.2%, with a high of 16.2% in the first quarter. . Quarterly projections show inflation of 6.3% in Q1, 5% in Q2, 5.4% in Q3 and 5.1% in Q4, Das noted.

Here is an explainer of some of the terms used by Governor Shaktikanta Das.

What is monetary policy?

Essentially, monetary policy is a set of financial tools and measures available from the RBI (or central bank of any country) to safeguard and promote economic growth. Although there are other ways for central banks to do this, monetary policy reviews are among the most effective.

Monetary policies essentially control the aggregate supply of money available to commercial banks and, indirectly, to individual users and businesses.

According to the RBI, the prime objective of monetary policy is to maintain price stability while keeping the growth objective in mind. Price stability is a necessary prerequisite for sustainable growth, the RBI noted on its website.

What is the repo rate?

The repo rate is the interest charged by the RBI when commercial banks borrow from them by selling their securities to the central bank. This is basically the interest charged by the RBI when banks borrow from them – just like commercial banks charge you interest for a car loan or home loan.

What is the reverse repo rate?

As the name suggests, this is the interest rate that the RBI pays commercial banks when they store excess liquidity reserves with the central bank. This is used by the RBI to control the flow of cash in the economy.

Basically, this allows the RBI to ‘mop up’ excess liquidity by making it more profitable for commercial banks to store liquidity reserves with the central bank.

Why is the repo rate usually higher than the repo rate?

Like all banks, the RBI has to earn more than it pays – this means that the interest it charges to commercial banks is higher than the interest it pays to the same banks.

LILY: RBI keeps policy rates unchanged and real GDP growth is expected at 7.2%

Why are repo and reverse repo rates essential?

They are key to boosting business credit and investment as India’s economy pushes to emerge from the double whammy of the pandemic and conflict in Ukraine. The Monetary Policy Committee’s review of the economy is critical for markets and general business sentiment.

The RBI uses the repo and reverse repo rates to slightly push the interest rates offered across the banking sector and, therefore, across the economy.

For example, by reducing the repo rate (the rate at which borrows from commercial banks), this can encourage economic activity because it allows your bank to reduce the interest rate on business loans, car loans, home loans, etc., as well as interest rate savings.

This encourages people to spend money because they see less value in keeping cash in banks.

Reverse repurchase does the opposite – by tricking commercial banks into hoarding its reserves, the RBI “mops up” the money and raises interest rates for you. This encourages people to hoard rather than spend, and reduces the amount of cash in circulation and therefore also controls inflation.

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