Repo Rate

Notes

The repo rate (repurchase rate) is the rate at which the Reserve Bank of India lends short-term funds to commercial banks against government securities (G-secs), with an agreement to repurchase them later. It is the main policy rate set by the Monetary Policy Committee (MPC).

How it works

A bank facing a liquidity shortage sells G-secs to the RBI and borrows cash overnight (or for 7 or 14 days under term repo), agreeing to buy the securities back at a higher price; the difference is the repo rate.
This is done under the Liquidity Adjustment Facility (LAF).

Effects

Rate hike: borrowing becomes costlier, so lending rates rise; credit and demand fall; this reduces inflation but may slow growth.
Rate cut: cheaper credit; demand and investment rise; supports growth, with some inflation risk.

LAF corridor

Repo rate is the mid-point. The Standing Deposit Facility (SDF) rate is the floor (repo minus 0.25%), and the Marginal Standing Facility (MSF) rate is the ceiling (repo plus 0.25%). The Bank Rate is aligned to the MSF rate. The operating target is the weighted average call rate (WACR) in the overnight money market.

Transmission to borrowers

Lending rates have moved from the Base Rate (2010) to MCLR (April 2016) and then to the External Benchmark-based Lending Rate (EBLR), mandatory for new floating-rate retail and MSME loans since October 2019. The most common benchmark is the repo rate itself (Repo-Linked Lending Rate, RLLR), so a repo change quickly changes EMIs.
Transmission to deposit rates and to long-term loans is slower and partial.

Related: Reverse repo rate (Topic 262); neutral rate; the RBI's inflation target of 4% (+/-2%). The current repo rate changes with MPC decisions, so check the latest RBI announcement.

Key Points

Repo rate: the rate at which the RBI lends to banks against G-secs; the main policy rate.
Higher repo curbs inflation and credit; lower repo promotes growth.
Corridor: SDF (floor), repo (middle), MSF (ceiling); the Bank Rate equals MSF.
Lending is linked to the repo (EBLR/RLLR) since 2019.
Set by the MPC.

MCQs

Q1. The rate at which the RBI lends short-term to commercial banks against government securities is the: (a) Reverse repo rate (b) Repo rate (c) Bank rate (d) CRR Ans: (b).

Q2. An increase in the repo rate is likely to: (a) Reduce lending rates (b) Increase lending rates and reduce credit demand (c) Increase money supply (d) Reduce the SLR Ans: (b).

Q3. The MSF rate is: (a) Repo rate minus 0.25% (b) Repo rate plus 0.25% (c) Equal to the SDF rate (d) Equal to CRR Ans: (b).