What is Reverse Repo Rate in India in simple terms?

‘What is Reverse Repo Rate in India in simple terms?’ is a part of the series where we discuss some of the measures the Reserve Bank of India takes to control Inflation and economic growth. Previously, we have discussed CRRSLR, and Repo Rate. However, all these ratios and rates are the parts of the monetary policy of the Reserve Bank of India to manage the interest rates and money supply in the economy.

This post contains the following:

  • What is Reverse Repo Rate?
  • How does Reverse Repo Rate work?
  • How does the Reserve bank of India use it?
  • The difference between the Repo rate and Reverse Repo Rate
  • The bottom line

What is Reverse Repo Rate?

The Reserve bank of India also takes loans from the commercial banks whenever required. It is to control the money supply. However, it has to pay an interest rate for that, just like banks do when they take loans. That is called the Reverse Repo Rate. Thus, Reverse Repo Rate is nothing but the interest rate the Reserve bank of India has to pay to the banks when it takes a loan. It is represented in a percentage form. It changes from time to time.

Follow the process to check the current Repo Rate: https://www.rbi.org.in/  Current Rates  Reverse Repo Rate

Let’s see how it works.

How does Reverse Repo Rate work?

The Reverse Repo is the mirror image of the Repo Rate. The funda is simple in both Repo cases: a government security holder needs money, takes loan keeping the government security as collateral, and agrees to repurchase it at a future date. However, in this case, it is the bank who gives money to India’s reserve bank. You might be wondering why banks prefer to keep their money with the Reserve bank of India.

Just imagine a situation. A bank has an excess amount of money and does not find suitable borrowers, then what it will do. It would like to keep the money with the Reserve bank of India until it finds suitable borrowers. In another situation, suppose the Reserve bank of India raises the Reverse Repo Rate. That means it agrees to pay more in the form of interest. In that case, banks prefer to lend to the Reserve bank of India than any other borrowers. It is a much safer approach.

Now, let’s understand it with an example.

An example

Suppose the State bank of India preferred to keep its excess cash say about Rs 100 Crore with the Reserve bank of India. Then the Reserve bank of India gives government securities worth Rs 100 Crore and takes the money. It also agrees to repurchase the government securities at a future date or when the agreement ends. Suppose the bank needs money and completes the deal after one month. Then the Reserve bank of India pays Rs 27,91,667 as interest (assuming a Reverse Repo Rate of 3.35%) along with Rs 100 Crore and gets back the government securities. That’s simple, isn’t it?

How does the Reserve bank of India use it?

The Reserve bank of India is a watchdog of our economy. It has some tools to make a balance between Inflation and growth. The Reverse Repo Rate is one of the devices. Let’s see how the Reserve bank of India uses it. We will take two different scenarios here.

Scenario – 1

Suppose it is a period of high Inflation, then it needs to be controlled. Thus, the Reserve bank of India raises the Reverse Repo Rate. Once, banks feel that they are getting a higher interest when keeping their excess money with the Reserve bank of India, that is generally the safest approach, they redirect their money to it. Now, they have less amount of money to disburse loans. That makes interest rates go up. Once interest rates go up, loans become unattracted to borrowers.

As a result, people don’t prefer to take loans. The percentage of borrowers is reduced. It reduces the money flow into an economy. Further, less money in an economy causes a lesser demand for goods and services. As a result, the prices of products and services go down. It controls Inflation at the cost of compromised growth.

Scenario – 2

Today, the whole world suffers from a pandemic situation. What is the Reserve bank of India or the Central banks of other countries doing now? That’s simple. They are lowering their Repo and Reverse Repo Rates to push up the economy. As we are focusing on the latter one, let’s see what happens after that.

Once the Reverse Repo Rate is decreased, banks don’t like to put their excess cash with the Reserve bank of India. They want to disburse loans. To make things simple, they lower the interest rate of every type of loan. Once interest rates go down, loans become attracted to borrowers.

As a result, people prefer to take loans—the percentage of borrowers increases. Further, the money flow into an economy also increases. It causes more demand for goods and services. Consequently, the prices of products and services go up, causing Inflation and pushing up the economy.

Tabular Data

OBJECTIVEREVERSE REPO RATELOANSMONEY-SUPPLYDEMANDINFLATIONGROWTH
To control Inflation
 
To support growth
The Role of the Reserve bank of India
TABLE – 1

The difference between the Repo rate and Reverse Repo Rate

  • Repo Rate is the interest rate paid by the banks to the Reserve bank of India, whereas Reverse Repo Rate is the interest rate paid by the Reserve bank of India to the banks.
  • Repo Rate means Repurchase Option and Reverse Repo Rate means Reverse Repurchase Option.
  • The primary purpose of the Repo Rate is to control Inflation, whereas the primary purpose of the Reverse Repo Rate is to control the money supply in the economy.
  • The Repo Rate is always higher than its counterpart.

The bottom line

Things are not as easy as it is seen in the theory. As a watchdog of the economy, the Reserve bank of India takes all necessary steps to maintain a balance between Inflation and growth. However, in a few cases, it goes out of control.

Take the recent case. The world is facing a pandemic situation, and everyone is health concerned. Meanwhile, the Central banks all over the world are trying to get out of the worst kind of economic recession. They are doing everything they could do. But, the situation is worsening. People are not going to take loans, whatever cheap it may look. Further, employment, lesser demand for products and services, ghost cities have created panic among manufactures. Moreover, we don’t know when the hell ‘Covid-19’ is going out of our lives.

It is a condition the world has never seen before. However, we should not lose hope. We are going to win, and our economy will also come to the right track in the meantime.

Thank you. I hope you have enjoyed the topic. Now, you should share the post with the people who might have an interest in the subject. Further, I need your opinions, suggestions, remarks, and comments to serve you better.

Thanks and regards,

finguru@finlessons.com

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