Why is repo rate increased?

Repo rate is the rate at which a central bank (RBI in India) lends money to the commercial banks in the country if they have a shortfall. When lending becomes expensive, the banks increase interest rates on fixed deposits (especially long periods) so that it will encourage more people to make deposits and in turn, they will have enough funds to lend, instead of taking it at a high-interest rate from the central bank.

The reason repo rates are hiked is to encourage deposits. A higher interest rate will make savings in different forms attractive, and loans will become expensive. In this way, the money in circulation will be reduced. With less money, the retail demand for goods will fall and inflation will be controlled.

Fixed deposits

The first to initiate the rise in fixed deposit interest rates, even before the RBI repo rate hike was SBI (State Bank of India), that has revised its rates by 5 to 20 basis points on most long-term tenures. HDFC increased its lending rates this week. Soon, others financial institutes will revise their interest rates.

Small savings schemes

Small savings schemes include National Savings Scheme, 5-year post office monthly income schemes, Kisan Vikas Patra, Public Provident Fund (PPF), etc.

The interest rates on these are revised every three months (quarterly cycles) since April 2016, however, it has remained unchanged since January 2018. The next date for revision of interest rates on these government-backed savings schemes is 15 September.

Even if the interest rates are not increased in the coming end of the current quarter, these schemes fetch higher interest returns than most fixed deposit or recurring deposit schemes provided by banks, making them a better bet.