Repo and Reverse repo rates in india
“The rate at which RBI lends to banks against government securities is called Repo Rate“. This definition is self explanatory. When banks require short term funds, they can borrow from RBI at repo rate.
REVERSE REPO RATE
“The rate at which Banks park their excess funds in RBI to earn interest is called Reverse Repo Rate“. This again is self explanatory. When Banks have idle money, they can park their excess money to RBI, and earn interest on that idle money.
INFLATION AND ITS CONTROL:
Now, you may already know that Inflation occurs when there is excess liquidity (money) in market than demand of goods. As a result, price of general commodities rises. So, in such cases, RBI needs to reduce liquidity (money) from the market.
There are two ways:
1) It may increase Reverse Repo Rate
2) It may increase Repo Rate
REPO RATE: Increasing Repo rate will make the loans more expensive. Hence, Banks will stop (or decrease) taking loans from RBI. As a result, less money will be injected in the market. This will help control inflation.
REVERSE REPO RATE: Increasing Reverse Repo Rate will make Banks park more of their excess funds with RBI for earning more interest.
For this, Banks may introduce various schemes to general public with attractive interest rate. Public will invest in these schemes, which banks will then give to RBI. In other words, Increasing Reverse Repo rate will absorb excess liquidity from the market. Thereby controlling inflation by limiting liquidity in the market.
DEFLATION AND ITS CONTROL:
The reverse is true for Deflation.
1) RBI may decrease Repo Rate
2) RBI may decrease Reverse Repo Rate
Readers are expected to understand the deflation scenario on their own 🙂