On May 4, 2022, the Reserve Bank of India hiked its benchmark repo rate by 40 bps in an unscheduled policy review with the objective of controlling inflation. The RBI Governor Shaktikanta Das while announcing the decision said that the global economic recovery was losing momentum and geopolitical tension has been pushing inflation up.
The Monetary Policy Committee of RBI voted unanimously to increase the repo rate (a rate at which the central bank of a country gives loans to commercial banks against securities) by 40 bps to 4.4 per cent with immediate effect. The committee also decided to continue with an accommodative monetary policy stance.
The repo rate has been hiked for the first time in four years. The last increase by 25 basis points to 6.50 per cent in the repo rate was witnessed in August 2018.
The Central Bank has also announced a 50 basis point increase in the cash reserve ratio- the percentage of cash required to be kept in reserves as against the bank’s total deposits – in a bid to tighten the liquidity. An increase in the cash reserve ratio will suck out excess liquidity from the market.
Now, let’s understand what is a repo rate and what has led to an increase in the repo rate.
WHAT IS THE REPO RATE?
In simple terms, the repo rate refers to a rate at which a nation’s central bank (Reserve Bank of India in India) lends money to commercial banks in case of any shortfall of funds. Repo Rate is subject to changes as per the policies of RBI. It is an important tool used by the central bank to control the inflation trends and maintain the liquidity in the market.
The repo rate and inflation have an inverse relationship. If the repo rate increases, inflation reduces and if the rate lowers, the inflation increases.
As per the statement by RBI Governor Shaktikanta Das, the repo rate has been increased due to a number of reasons:
- Rising Inflation
- High crude Oil Prices
- Geopolitical Tensions
- Shortage of Commodities at the global level
“The decision today to raise repo rate may be seen as a reversal of rate action of May 2020. Last month, we had set out a stance of withdrawal of accommodation. Today’s action needs to be seen in line with that action,” said the Governor, according to NDTV.
Here’s a snapshot of all the repo rate changes that have been done by RBI since 2018:
|Last Update||Repo Rate|
CONSEQUENCES OF HIKE IN REPO RATE?
RBI’s strategic move of increasing the repo rate will push banks and non-banking financial institutions (NBFCs) to hike lending and deposit rates. This will lead to an increase in the interest rates that the banks charge for loans.
Any change in the repo rate majorly affects the real estate market, as there is a direct link between the repo rate and the home loan rate. As the repo rate has increased, the bank will increase interest rates on loans. That is why home loans and auto loans are set to become costlier.
However, an immediate increase in home loan rates is not expected by commercial banks. So, this makes a good time for homebuyers to buy their dream home now. With home prices expected to rise in the near future, it is the perfect time for homebuyers to take advantage of the current low home loan rates before the banks decide to change the interest rates.
THE EFFECT OF THE REPO RATE ON THE INDIAN ECONOMY
Repo Rate is an effective tool used by the central bank to control and monitor the inflation, liquidity and money supply in the market. Any change in repo rate directly affects the cost of borrowing by banks. If the economy witnesses a rise in inflation, RBI increases the repo rate to control it. An increase in the repo rate leads to an increase in the cost of borrowing for businesses, which results in lowering the investment and cash flow in the market.
In case of a liquidity crunch in the economy, the Central Bank reduces the repo rate which leads to a reduction in the cost of borrowings and therefore increases the cash flow in the economy.
WHAT HAS LED TO THE PRICE RISE IN INDIA?
The ongoing war between Russia and Ukraine has adversely affected the market supply chain, leading to an increase in the price of crude oil and other important commodities. The war has affected all economies of the world.
Crude oil prices had mostly been on the rise in March 2022, after Russia started invading Ukraine on February 24. The Indian oil companies had no other option but to pass on the high import cost of global crude oil prices by hiking the prices of domestic petrol and diesel from March 22. Furthermore, the prices of domestic cooking gas have also witnessed a considerable hike.
In the past few months, prices of almost every essential commodity have seen a hike as the companies are passing on higher prices to consumers as they deal with high input costs.
In India, inflation has emerged as a major concern over the last few months. Shaktikanta Das made an assuring statement while announcing the decision to increase the repo rate, he said “We, in the RBI, remain steadfast in our commitment to contain inflation and support growth. Inflation must be tamed in order to keep the Indian economy resolute on its course to sustained and inclusive growth. The biggest contribution to overall macroeconomic and financial stability as well as sustainable growth would come from our effort to maintain price stability.”