Effects of Repo Rate On The Economy

Effects of Repo Rate on the Economy

Effects of Repo Rate On The Economy

Repo Rate Impact On The Economy


The Repo Rate can cause a range of effects on the overall economy whether it is an impact on the banking sector, an impact on the an individual(average citizen) or some other aspect of the Indian economy. In this article, we will discuss Effects of Repo Rate On The Economy in detail.

Repo rate is a key instrument of the Indian monetary policy. It can regulate country’s money supply, inflation levels and liquidity. Additionally, the levels of repo is directly related to the cost of borrowing for banks. For example, Higher the repo rate, higher will be the cost of borrowing for banks and vice-versa.

Effects of Repo Rate On The Economy

Effects of Repo Rate on the Economy
Effects of Repo Rate on the Economy

A. Impact on the Banking System

Increase in Repo Rate: 

  • Lending rates and deposits offered by banks are impacted by a rise or fall of repo rate. However, it may not have an immediate effect. Banks may analyse their liquidity position and cost of funds before increasing the deposit rates and the lending rates.
  • After analysing the cost of funds and liquidity position, banks may begin to pass on their interest rate burden to its end customer in the form of elevated lending rates. That means higher equated monthly instalment for existing borrowers and higher rate of credit for new borrowers.
  • Home loans and other floating rate loans get majorly affected due to rate change. Higher lending rates may lead to a slowdown of the lending business for the banking sector, which will have an impact on their profitability.
  • Post analysis of liquidity position, banks may also hike the rate of bank deposit offered to customers to attract more inflow of funds into the banking system.

Reduction in Repo Rate: 

  • Banking is the first sector to get affected by any change in monetary policies. It’s a big relief to bank when Reserve Bank of India decides to reduce the repo rate. With the dip in repo rate, banks can borrow from Reserve Bank of India at a affordable rate.
  • With the accessibility of low cost credit, banks may even reduce the lending rates to its customer after analysing the liquidity condition and the deposit inflows. Banks may offer credit to its end customer at a reduced rate.
  • As bank loans get affordable, consumers can spend and borrow more while spending a lot less in borrowing. Increased lending business will boost the profitability of the overall banking system.
  • However, lending rate cut and deposit rate hikes are purely dependant on the bank’s liquidity position and deposit demand from customers.

B. Impact on An Individual

Increase in Repo rate: 

  • When Reserve Bank of India decides to hike the repo rate; it becomes costlier for commercial banks to borrow short term funds from Reserve Bank of India. Increased repo rate discourages the bank from availing short-term loans and advances from RBI.
  • Due to non availability of low cost funds, banks my hike the lending rate for its customers to pass on its high interest burden. That means loan becomes costlier for a common man. This may automatically reduce consumer purchasing power.
  • On the other hand, banks may begin to offer fixed deposits at increased rate to attract more inflow of funds. It basically helps consumer to save more with increased rate on bank deposits.

Reduction in Repo rate: 

  • When Reserve Bank of India decides to reduce the repo rate, loans and advances become affordable for the commercial banks as they can avail short-term credit from Reserve Bank of India at the reduced rate.
  • Rate cut may push banks to reduce their prime lending rate. Reduction in prime lending rate encourages more borrowers by making credit accessible at lower rates to the common man.
  • With the increased opportunity to borrow, consumer can spend more and avail loans to achieve future financial goals easily. One should understand the repo rates to manage their finances in a better way.

C. Impact on the Economy

Increase in Repo Rate :

  • When Reserve Bank of India increases repo rates, it becomes costlier for banks to borrow. In other words, banks will have to pay more interest on their short-term borrowings from the Reserve Bank of India. Costlier credit option for banks prompts them to hike the lending rate which they offer to their end customers.
  • Expensive bank loans discourage the borrower from availing credit. This reduces the money supply in the market and thereby stabilizes the liquidity in the system. Consumption, Expansion and production also take a downfall with the lesser money supply. Expensive credit hinders economic development and GDP growth even though inflation rate comes under control.
  • Hence, Reserve Bank of India revises repo rate on a regular basis to keep the inflation rate under control and also to strike a balance between both economic growth and rising inflation.

Here are some of the vital impacts of increase in repo rate on economy:

  1. Borrowing becomes costlier for banks as they avail short-term credit from Reserve Bank of India at relatively higher rate. With the costlier credit for banks, they will ultimately lend the consumers at relatively increased rate. This may lead to costlier bank loans for customers. As the lending get expensive, borrower gets discouraged and demand for bank loan reduces.
  2. Reduced borrowing results in lower consumption demand which will lead to economic slowdown that hinders the growth of GDP for the short term. As the consumption demand reduces, profitability of every sector in the economic system takes a hit.
  3. Corporate loan buyers get discouraged to avail credit with the hike in repo rate also discourages the. As the availability of business capital becomes expensive, production and expansion plans of corporate take a backstop.
  4. Increase in repo rate reduces the money supply in the economic system and thereby reduces the rate of inflation.

Reduction in Repo Rate : 

  • When Reserve Bank of India decides to cut the repo rate, the short-term loans for commercial banks become affordable. This prompts them to offer consumer loans at a relatively discount rate. Many a times, base lending rate gets reduced with the reduction in repo rate.
  • Base lending rate is the rate below which banks cannot lend to its customers. Reduced base rate increases the consumption as people will have more money at their disposal. Increased consumption positively impacts the country’s Gross Domestic Product (GDP) growth.
  • Affordable availability of credit encourages businesses to grow and expand. Prices of products get lower with the availability of low cost capital. New investments lead to better employment opportunity in the economy.

Here are some of the key impacts of repo rate cut on economy :

  1. Consumption Demand : Demand for auto, housing and every sector will rise due to availability of affordable bank loans to customer. Economic growth will take a upward trend with its every sector growing due to increased consumption demand.
  2. Economic activities picks up: With the falling prices, economy grows at a slower rate. Repo rate cut boosts the economic activities and prompts healthy growth with adequate supply of money in the market.
  3. Boost to foreign investments: Bank lending rates get reduced with the cut in repo rate. Lower borrowing rates will encourage the foreign players to investment in Indian financial market.
  4. It is important to note that the repo rate cut is not the only monetary measure for economic growth.

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