Effects of Reverse Repo Rate on Economy

Reverse Repo Rate Impacts on Indian Economy

Introduction

The Reverse Repo Rate just like repo rate can induce many effects on the whole economy, including an impact on the banking sector, on the end customer and some other aspect of the Indian economy. In this article, we will discuss Effects of Reverse Repo Rate on the Economy in detail.

Reverse Repo Rate is a key instrument of the Indian monetary policy. It is basically for reducing the excess of liquidity in the system. And it is obvious when the liquidity is checked through the policy rate, the inflation will come down.

Effects of Reverse Repo Rate on the Economy

A. Impact on Banking System

Increase in Reverse Repo Rate : 

• Whenever there is excessive money floating in the banking system, Reserve Bank of India decides to increase the reverse repo rate.
• When there is an increase in reverse repo rate, banks can earn higher interest on their excess funds lent to the Reserve Bank of India.
• This is a safe investment option for the banks also. With banks earning more on their investments, automatically it will have a positive impact on the profitability of banking business.

Reduction in Reverse Repo Rate : 

• Whenever Reserve Bank of India decides to reduce the reverse repo rate; banks cannot earn more on the money lent to Reserve Bank of India.
• There will not be any positive impact on profitability of banking business with the reduced rate.

B. Impact on Common Man

Increase in Reverse Repo Rate : 

• Soaring inflation is always a concern for common of the country. Essential commodities and basic food items get costlier with the rising rate of inflation.
• RBI sucks the surplus money in the financial system by increasing the reverse repo rate. With the increased reverse repo rate, more and more banks will start supplying excessive funds to Reserve Bank of India.
• This will reduce the money supply in the financial market. Due to reduced money supply in the market, inflation will also come down. Increased reverse repo rate helps common man by curbing the rate of inflation.

Reduction in Reverse Repo Rate : 

• With the lesser investment options available to banks due to reduced reverse repo rate, banks earning on investment will reduce.
• This gradually increases the supply of money in the market which causes inflation to rise. Rising inflation affects the life of common man.

C. Impact on the Economy

• Reserve Bank of India increases the reverse repo rate with the objective to flush out the excess liquidity in the financial system by keeping check on inflation rate.
• The most important effect of Reverse Repo Rate is in the reduction of inflation. For quite some time, the control of inflation has taken centre stage in India’s monetary policy. When Reserve Bank wants to tighten credit, it increases the Reverse Repo Rate.
• When reverse repo rate is increased by Central Bank, it attracts deposit of funds by commercial banks leaving less money with the banks for lending activities. Due to reduced funds availability in case of less liquidity, banks increase their lending rates.
• As a result, consumers are left with the only choice of costlier borrowing from banks. As a result borrowing is discouraged and people are left with less disposable money and less buying opportunity.
• This will cause an imbalance between supply and demand of commodities in the market. With more items/services offered and less customers to avail those, the businessmen will be forced to lower the prices of their product. This will lead to lowering of inflation.
• Variation in Repo rate and Reverse Repo Rate can have significant influence on the applicable interest rates of various banking products like mortgages as well as different types of loans and savings.

Reverse Repo rate is Lowerd to 5.75% by RBI April 2019 MPC Meeting

The Reserve Bank of India on 4th April,2019, lowered the repo rate by 25 basis points to 6%. The reverse repo rate, too, was lowered to 5.75% from 6%.

Why RBI Had Decraesed Repo & Reverse Repo Rates?

1. Since the last Bi-Monthly Monetary Policy Committee meeting in February 2019, the Global Economic Activity had been losing pace.
2. Also the Crude Oil Prices rose around 10% since Frb 2019.
3. So it was noted by the Monetary Policy Committee that the Output Gap was remained negative and the domestic economy is facing headwinds, especially on the global front.
4. Thus, there was a Need is to Strengthen Domestic Growth impulsed by spurring private investment which had remained sluggish.
5. So, RBI had cut Repo & Reverse Repo Rates by 25 basis points in order to drive and strengthen the domestic growth of the Indian economy.