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Difference and Impact between Repo Rate & Reverse Repo Rate

The Reserve Bank of India is responsible to structure and govern the monetary policy to control the flow of money in the economy and to simulate different aspects of growth. The primary objective of this policy is to improve the country’s financial system.

Repo rate and reverse repo rate are two significant instruments of RBI’s monetary policy. It helps this apex body to control the money supply.

The current rbi repo rate was last revised in October 2019, and it stands at 5.15%, and the current reverse repo rate is 4.90%.

 

Differences –

 

Repo rate

Repo or repurchase rate is the rate of interest at which RBI lends money to other financial institutions of the country. It is used to curb inflation by increasing the money supply in the economy.

It is collateral-backed lending from RBI where financial institutions provide government securities and bonds to the RBI with an agreement to repurchase them in future. Financial institutions have to pay a predetermined price, including interest.

Reverse repo rate

As the name suggests, it is the opposite of repo rate. It is the rate at which RBI borrows funds from financial institutions. They receive interest as per the reverse repo rate on their deposit.

Reverse repo rate is a mechanism used to decrease the money supply in an economy during deflation. Funds borrowed by RBI at reverse repo rate are not collateral-backed.

 

Impacts –

 

Repo rate

When repo rate surges, it becomes expensive for financial institutions to borrow money from RBI. It results in a higher rate of interest on various loans, especially the ones based on floating interest rates, like MCLR based home loans.

Thus, lenders cannot offer loans at a lower interest rate. A higher rate of interest also discourages citizens from borrowing and subsequently reduces their purchasing power.

This creates a deficit of money in the system, and it hinders the economy’s growth by reducing consumption and subsequently, production.

Additionally, an increase in this rate may also increase the deposit rate, which improves the inflow of money. Comparatively, a decrease in this rate creates an opposite scenario – it encourages borrowers and ultimately has a positive effect on the GDP.

Reverse repo rate

The primary objective of the reverse repo rate is to control the money supply in an economy during a downturn. RBI increases this rate to encourage financial institutions to deposit their excess funds and create a shortage in the market, thereby curbing deflation. A decrease in this rate creates an opposite situation in the economy.

The recent revision of these two rates has lowered the interest rate on various mortgage loans such as home loans. Apart from gathering information about this rate revision, borrowers should know other things before taking a home loan.

Repo rate and reverse repo rate are two crucial factors of the monetary policy of India, and their fluctuation has a direct impact on its economy. Individuals planning to avail a housing loan should know what to expect from this repo rate cut before applying.

 

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