The policy repo rate (Repurchase Option/Repurchase Arrangement) is the fixed interest rate at which the RBI lends short term funds to the commercial banks against approved government securities.
It serves as a macro-economic tool under the Liquidity Adjustment Facility (LAF) to manage the money supply, economic growth and price stability.
Transfer Mechanism
When a banks falls short of liquidity, they pledge government securities to the RBI and borrower cash, agreeing to repurchase them back at a slightly higher price - the repo rate.
The RBI uses this rate to :
- Control Inflation : Hike in repo rate increases the cost of funds for the banks which pass on the burden to the borrowers. This increase in cost of debt restricts the credit growth and helps in reduction of demand for the goods and services which forces a reduction in the price level in the economy thus cooling inflation.
- Growth Stimulation : Lowering the repo rate in the country works the opposite. It reduced the cost of debt. This incentivizes businesses to borrower more and expand operations, creating more demand for raw material and services and also jobs. This boosts the over all economy which also raises the prices as the demand increases.
Historical Uses
The repo is decided based on the broader global and domestic markets and events to ensure that the domestic economic growth is balanced.
- Global Financial Crisis 2008-2009 : Due to liquidity crunch, RBI slashed the repo from 9.00% to 4.75% by April 2009. This reduction is cost of debt injected massive liquidity into the economy.
- High Inflation Cycle 2010-2011 : After reduction in repo during 2009-2010, the prices and inflation rose drastically forcing RBI to increase the repo from 5.00% in March 2010 to 8.50% in Oct 2011.
- COVID 19 2020 : RBI brought the repo rate to a historic low of 4.00% to stimulate the halted economy.
- Post-Pandemic Tightening 2022-2023 : As supply chain bottlenecks and geopolitical tensions drove the prices high RBI increased the repo from 4.00% to 6.50% by Feb 2023.