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Understanding repo rate

The repo rate is the rate at which India’s central bank, the Reserve Bank of India (RBI), lends money to commercial banks. It is one of the RBI's key tools to keep inflation under control.

How repo rate works?

The RBI uses the repo rate to manage money flow in the Indian economy. When inflation grows, the RBI raises the repo rate. This increases the cost of borrowing from the central bank, reducing the money supply in the market and lowering inflation. In contrast, during a recession, the RBI reduces repo rates to encourage borrowing and increase economic activity.

Thus, a higher repo rate makes borrowing more expensive for banks, whereas a lower repo rate makes borrowing cheaper.

The impact of repo rates on the economy

Interest rates: Changes in the repo rate affect interest rates throughout the economy. When the central bank increases the repo rate, commercial banks usually raise their loan interest rates. This makes borrowing more expensive, which in turn results in lower expenditure, especially on commodities such as homes and cars.

Inflation: Central banks use the repo rate to control inflation. If the economy is growing too quickly and prices are rapidly rising, the central bank may raise the repo rate to slow spending and reduce inflation. Lowering the repo rate, on the other hand, might encourage borrowing and expenditure, thereby boosting a slowing economy.

Savings: Changes in repo rates also affect savings. Higher repo rates mean higher interest rates on fixed deposits, which benefits investors. Lower repo rates, on the other hand, may cause fixed deposit interest rates to fall, lowering the potential gains for investors.

Investment and economic growth: Businesses use loans to expand. A high repo rate raises borrowing costs, potentially delaying or limiting corporate investments. In contrast, a lower repo rate encourages borrowing and investments, hence encouraging economic development.

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