What is Repo Rate? How Does it Affect Inflation?

What is Repo Rate?

Repo Rate stands as an Interest Rate. When a bank borrows rupees from RBI for a short period of time, RBI charges them a Repo Rate. The cost of borrowing money for a short period of time is known as the Repo Rate. Or the rate at which the Reserve Bank of India lends money to commercial banks is defined as the Repo Rate.

What is Repo Rate? How Does it Affect Inflation?
What is Repo Rate? How Does it Affect Inflation?

Whenever any bank runs short of cash they borrow rupees from the RBI/ Central Bank. The interest rate at which the central bank lends money to commercial banks is broadly defined as Repo Rate. Repo refers to a bank’s deposit of government securities with the Reserve Bank of India as collateral for a short-term loan. They get an agreement in which the length of the loan is determined. The bank repays the money to the RBI with interest and receives the security back at the end of the period. For example, when we borrow money from banks, the banks will charge us interest on the amount borrowed. In the same way, banks borrow money from RBI and RBI borrows money from banks.

Banks take loans from the RBI for a number of reasons. It could be used to cover short-term financial shortfalls or legislative needs. In this scenario, the RBI acts as a banker to banks.

The Effect of the Repo Rate on Inflation or how does it affect inflation?

Inflation and the Repo Rate are interrelated. Inflation is defined as an increase in prices and a decrease in the purchasing power of money. The Repo Rate is increased by the RBI, the interest rates of borrowing rise and Inflation is also increased. An increase in the Repo rate will result in a decrease in the money supply and borrowing. So the general increase in the price level of goods and the economy is referred to as Inflation.

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The Repo Rate is increased by the Central Bank/RBI only. Repo Rates are used by the Reserve Bank of India (RBI), to manage healthy and sustainable liquidity in the financial system. When there is a cash shortage, commercial banks borrow money from the RBI, which they repay as per the Repo Rate. The repo rate is used by central bankers (RBI) to keep inflation under control.

So, when Repo Rate has increased, Inflation will go up, which means increased repo rates have an effect on everything from interest rates on all types of loans, credits and purchases. Also, when borrowing gets more expensive, consumers and businesses hold off their purchases. This, in turn, helps to reduce demand and keep product and service pricing under control. As a result, the money supply in the economy shrinks, and the rate of inflation decrease.

  • If Inflation increases, that means there is huge money in the market, the RBI borrow funds from banks in such a scenario, resulting in less money in the banks, less money in the market, and less money in the hands of the general public.
  • If Inflation decrease, there will be less money in the market, and banks will borrow money from the RBI, resulting in more money in banks, more money in the market, and more money in the hands of citizens.

Whether the Repo Rate is increased or decreased, directly impacts inflation; higher repo rates lead to increase inflation, while lower repo rates lead to decrease inflation. The Central Bank of India (RBI) is the only bank that controls inflation in the market through Reverse Repo rates and Higher Repo rates.

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