Repo rates and reverse repo rates are often used terms, especially after the Reserve Bank of India (RBI) Monetary Policy or just ahead of the same.
If you thought that banks always lend and may never be in need of money, you are wrong. Banks also need money from time to time to meet their short term funding requirements.
How the RBI controls interest rates in the country through repo rate?
Keeping inflation under control is one of the most important mandates of the RBI. It manages to keep inflation under control through the repo rate. How much of inflation is controlled through repo rate is often a matter of debate.
When the country's central bank feels that inflation is way above its target, or that inflation is high, it will increase the repo rate. When the interest rate that it lends money to banks increases, these lenders would be forced to increase their lending rates. If lending rates are increased it leads to lower demand for credit and hence an indirect control over inflation.
This is how it indirectly controls inflation through the repo rate.
What is the difference between the repo rate and the reverse repo rate?
Now,the country's central bank can also be in need of money sometimes and might borrow money from commercial banks in the country. While repo rate is the interest rate that the RBI charges to lend money to banks, reverse repo rate is just the opposite. So, reverse repo rate would be the interest rate charged by banks to the RBI.
The repo rates always tend to be higher than the reverse repo rate. At the moment the current repo rate is 7.25 per cent, while the current reverse repo rate is 6.25 per cent.
The Reserve Bank of India tends to alter these rates, during the monetary policy meet, but, could sometimes do so outside of the policy meet.
The reverse repo rate is hardly ever changed, while the repo rate undergoes a change from time to time, depending on inflation expectations and growth in the economy.
Current Repo rates and economic growth
One of the other objectives of the Reserve Bank of India is to balance inflation and growth expectations. Hence, it the country's central bank feels that it needs to push growth, it would cut repo rates. This would banks in the country to lower their lending rates as cost of funds become cheaper for them.
However, many banks may not oblige. This year the Reserve Bank of India has already cut repo rates thrice this year and is set to do so for the fourth time today. However, many banks have not obliged and cut their own lending rates.