What is Repo Rate, how does it impact general public?

New Delhi, Aug 07: Once in every two months, the Reserve Bank of India (RBI) makes a Monetary Policy announcement in which the central bank announces, among many other things, the changes in Repo Rate and Reverse Repo Rate. These rates are decided by the six-member monetary policy committee (MPC), which is headed by RBI Governor Shaktikanta Das.

So, what exactly do these rates indicate and why are these changed (increased or decreased) by the MPC. Repo Rate is the rate of interest at which the RBI lends money to banks. There are complex macro economic theories that explain these in terms that hardly make sense to a common person.

Simply put, the government would want to lower the Repo Rate when it wants to boost the economic activity. It is a way to infuse money or cash (liquidity) in the economy when there are signs of slow down. If Repo Rate comes down, then it would cost banks less to borrow from the RBI. This in turn allows the banks to lend in the marker at lower price without having to compromise with its own profit margin.

Once the lending rate of banks come down, the businesses would hesitate less to borrow and invest. Afterall, a business, of any kind, is about earning more money than what has been spent. A large part of what has been spent or investment would be in the form of borrowings from the bank.

So, what a business or company earns should not only cover its costs on wages to the employees, raw material, process involved in getting a product or service ready for market, but also the interest it pays on the money borrowed from banks. Essentially, when the lending rates come down, more businesses would want to borrow and invest in expansion of business which in turn boosts the economic activity.

This is the concept behind lending rates, repo rates and their relation with the economic activity on the ground. In reality, many other factors play a role in determining the level of economic activity. Like, if a company begins to scale up the operations just because the banks are lending at lesser rates without considering if there is even a demand in the market for its offerings, then it would be doomed. Repo Rate is one of the key factors that influences economic activity. More the economic activity, more would the jobs be created, the average incomes would go up which may increase spending. Once spending by people goes up, many sectors benefit. All this is a big economic cycle with chain of events affecting others, but the exact maginitude of affect of a particular move could be hard to find.

The Reserve Bank of India (RBI) reduced the repo rate or the rate at which it lends to banks by 35 basis points to 5.4 percent in the August policy review, citing downside risks to economic growth.

The reverse repo rate has been revised to 5.15 percent while the marginal standing facility rate and bank rate to 5.65 percent. The Monetary Policy Committee (MPC) has maintained accommodative stance.