RBI cuts the repo rate
Context:
Recently, RBI cut the repo rate by 6.25%, the first time in the last 5 years.
Relevance:
GS-03 (Economy)
What is the repo rate?
- The repo rate is the interest rate at which the RBI lends money to commercial banks in the event of any shortfall of funds.
- It is a crucial tool used by the RBI to control inflation and regulate the supply of money in the economy.
- When the RBI wants to make it more expensive for banks to borrow money, it increases the repo rate, thereby reducing the money supply in the economy.
- Conversely, a decrease in the repo rate makes borrowing cheaper, leading to an increase in the money supply.
Effects of the repo rate on the economy:
- Inflation Control: By adjusting the repo rate, the RBI can control inflation. When the repo rate is high, borrowing costs for businesses and consumers increase, leading to a reduction in spending and investment, which in turn helps in reducing inflation. On the other hand, a lower repo rate can stimulate spending and investment, which can lead to higher inflation if not controlled.
- Economic Growth: The repo rate also influences economic growth. A lower repo rate can boost economic activity by making loans cheaper for businesses and consumers, leading to increased spending and investment. This can stimulate economic growth. However, if the economy overheats, leading to high inflation, the RBI may raise the repo rate to cool down the economy.
- Loan and Deposit Rates: The repo rate directly affects the interest rates on loans and deposits. When the repo rate is increased, banks raise their loan and deposit rates, making loans more expensive and deposits more attractive. Conversely, a decrease in the repo rate leads to lower loan rates, making borrowing cheaper and stimulating economic activity.
- Exchange Rates and Foreign Investment: Changes in the repo rate can also influence exchange rates and foreign investment. A higher repo rate can attract foreign investors looking for better returns, leading to an appreciation of the domestic currency. Conversely, a lower repo rate may lead to a depreciation of the currency as investors seek higher returns elsewhere.
