Repo rate, reverse repo rate, interest rate

1. By:
Akshita, Vashita, Ayush, Karan, Lalit and Khaish

2.  Monetary policy is the process by which monetary authority
of a country , generally central bank (RBI in India) controls
the supply of money in the economy by its control over
interest rates in order to maintain price stability and achieve
high economic growth.
 There are several direct and indirect instruments that are used
for implementing monetary policy which include Cash
Reserve Ratio (CRR), Statutory Liquidity Ratio (SLR), Open
Market Operations (OMOs), Bank Rate, Marginal Standing
Facility (MSF), Repo Rate, Reverse Repo Rate etc.

3.  Other objectives of the monetary policy of India, as stated by
RBI, are:-
 Price Stability Price
Stability implies promoting economic development with
considerable emphasis on price stability. The centre of focus is
to facilitate the environment which is favourable to the
architecture that enables the developmental projects to run
swiftly while also maintaining reasonable price stability.
 Controlled Expansion Of Bank Credit
One of the important functions of RBI is the controlled
expansion of bank credit and money supply with special
attention to seasonal requirement for credit without affecting
the output. investment.

4.  Promotion of Fixed Investment
The aim here is to increase the productivity of investment by
restraining non essential fixed
 Restriction of Inventories and stocks
Overfilling of stocks and products becoming outdated due to
excess of stock often results in sickness of the unit. To avoid
this problem the central monetary authority carries out this
essential function of restricting the inventories. The main
objective of this policy is to avoid over-stocking and idle
money in the organization.
 To Promote Efficiency
It is another essential aspect where the central banks pay a lot
of attention. It tries to increase the efficiency in the financial

5. system and tries to incorporate structural changes such as
deregulating interest rates, ease operational constraints in the
credit delivery system, to introduce new money market
instruments etc.
 Reducing the Rigidity
RBI tries to bring about the flexibilities in the operations
which provide a considerable autonomy. It encourages more
competitive environment and diversification. It maintains its
control over financial system whenever and wherever
necessary to maintain the discipline and prudence in
operations of the financial system.

7.  Repo rate (Repurchase Rate) is the rate at which RBI lends
to the banks generally against government securities which is
kept as collateral with the central bank and when they pay the
money back to RBI, they take the collateral back.
 Reduction in Repo rate helps the commercial banks to get
money at a cheaper rate and increase in Repo rate discourages
the commercial banks to get money as the rate increases and
thus becomes expensive.
 So basically, increase in the cost of borrowing and lending of
the banks discourage the public to borrow money and
encourage them to deposit.
 The prevailing Repo Rate is 6%

8.  Impact on Economy
When the repo rate is raised, banks are compelled to pay
higher interest to the RBI which in turn prompts them to raise
the interest rates on loans they offer to customers. The
customers then are dissuaded in taking credit from banks,
leading to a shortage of money in the economy and less
liquidity.

9.  Reverse Repo rate (Reverse Repurchase Rate) is the rate at
which RBI borrows money from the commercial banks. It is a
monetary policy instrument which can be used to control the
money supply in the country.
 In this, the banks deposit their excess funds with RBI.
 The increase in Repo rate tends to increase the cost of
borrowing and lending of the banks which discourage the
public to borrow money and encourages them to deposit.
 The Reverse repo rate is always less than the repo rate as RBI
cannot give more interest on deposits and charge lesser
interest on loans.
 Prevailing Reverse-Repo Rate is 5.75%

10.  Impact on economy
Increasing repo will squeeze the liquidity out of the system
and increase the interest rates, which will then reduce the
demand for funds and reduce inflation.

11.  An interest rate, is the amount of interest due per period, as a
proportion of the amount lent, deposited or borrowed.
 Interest rate targets are a vital tool of monetary policy and are
taken into account when dealing with variables
like investment, inflation, and unemployment.
 The central banks of countries generally tend to reduce
interest rates when they wish to increase investment and
consumption in the country's economy and vice versa.
 Reasons for interest rate changes: Political short-term gain,
Inflationary expectations, Deferred consumption etc.
 Any hike in the bank rate, repo rate or reverse repo rate will
lead to a rise in interest rates in the economy and vice versa.

12.  The term structure of interest rates is the relationship
between interest rates or bond yields and different terms or
maturities. It is also known as a yield curve, and plays a
central role in an economy. So basically, it a graph that plots
the yields of similar-quality bonds against their maturities,
from shortest to longest.
 It reflects expectations of market participants about future
changes in interest rates and their assessment of monetary
policy conditions.
 This implies that the term structure of interest rates are
generally indicative of future interest rates, which in turn are
indicative of an economy's expansion or contraction.
Therefore, yield curves and changes in these curves can
provide a great deal of information.

13.  The term structure of interest rates takes three primary shapes.
If short-term yields are lower than long-term yields, the curve
slopes upwards and the curve is called a positive (or "normal")
yield curve. This indicates that investors desire a higher rate
of return for taking the increased risk of lending their money
for a longer time period.
 It is also believe that a steep positive curve means that
investors expect strong future economic growth with higher
future inflation (and thus higher interest rates) Below is an
example of a normal yield curve: