Business

The Key Difference Between Repo Rates & Reverse Repo Rates

The Monetary Policy Committee (MPC) of the Reserve Bank of India reduced the repo rates five times this year by 135 basis points (100 basis points = 1%) since February 2019 when it stood at 6.25%. Currently, this rate stands at 5.15%. 

In the MPC’s December meeting, the committee decided to maintain the rate at 5.15%, which was set during the October meeting. On the other hand, reverse repo rates stood at 4.9%. 

These reductions come in the context of a waning Indian economy. India is in the midst of a major economic crisis with GDP growth rate falling at a 6-year low of 4.5% in the September quarter. Therefore, the RBI has adopted these accommodative measures to revive the economy by enabling financial institutions to make loans easily available to borrowers at cheaper interest rates. 

Difference between Repo Rates and Reverse Repo Rates 

The repo rate stands for the repurchasing option. It is the interest rate that the Reserve Bank of India levies on loans to financial institutions. These financial institutions provide securities such as treasury bills with RBI to avail overnight loans from it. 

Reverse repo rate is the rate at which RBI borrows from financial institutions for the short term. Both these rates are essential monetary policies at RBI’s disposal, which it employs during different phases of the economy. 

The effects of repo rate and reverse repo rates are opposite, utilized to relatively increase the total money supply in an economy, or restrict the same. While the former boost the growth rate of India, the latter is implemented when adverse situations such as inflation affect the wellbeing of the consumers.

Effect of the Repo and Reverse Repo Rate on recession 

A decrease in the repo rate reduces the cost of borrowing in a country. By encouraging its residents to borrow and spend more, repo rates effectively increase the total production undertaken to meet the consequent rise in aggregate demand, which, in turn positively impacts the GDP of the country. Owing to such rises, reducing repo rates is a primary tool utilized to tackle the slowdown of the country. 

A low repo rate enables financial institutions to avail funds from RBI at cheaper rates, which will further translate to low rates for borrowers. Repo rate has a major impact on big-ticket credit facilities such as home loans due to change in home loan rates. It enables borrowers to avail loans at convenient terms, which improve their purchasing power or consumption capacity. It is one of the reasons why this is the best time to buy your dream house.

A similar effect is reflected by increasing the prevailing reverse repo rates, as the income accrued by financial institutions to by keeping their money with the RBI falls. Financial institutions tend to extend the credits to prospective borrowers for higher returns.

Effect of the Repo and Reverse Repo Rate on inflation

The reverse rate comes in handy during times of high rate of inflation prevailing in the country. As inflation generates an adverse impact on the consumers, contractionary monetary policy in the form of lower repo rates and increased reverse repo rates is undertaken to overcome the same. While the former increases the cost of borrowing, the latter increases the returns generated through funds kept with the central bank respectively. Both effectively reduce total funds present with financial institutions to lend to the residents, lowering the total demand of the country. Such reduced demand rates reduce the prevailing price level, thereby lowering the inflation rate of an economy.

With repo rates being at a 6-year low, housing loan interest rates have gone down exceptionally. Additionally, government measures such as additional tax benefit in the form of Section 80EEA further conveniences borrowers to avail home loans. 

In case you had availed home loans before lending rates were reduced, you can avail the facility of the balance transfer from certain lenders. Such low rates are one of the reasons to refinance your home loan now.

However, as most financial institutions have not yet translated such low repo rates to their customers, you need to wait out until all financial institutions implement it. It will allow you to make a more informed decision. 

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