Reserve Bank of India is the monetary policy maker of Indian Economy. It formulates polices to keep a healthy balance in the economic ecosystem of the country. To achieve this fine balance, Reserve Bank of India formulates various strategies and tools. One such potent strategy is “Rate Cut”. Reserve Bank of India, if and when required for the economy, announces rate cuts in its monetary policies. Rate cuts have an impact on the availability of funds in the economy and it is considered as an important tool to curb inflation. Before discussing more about rate cuts and its impact, let us first understand two major rates those are exercised by the RBI and are often updated while formulating policies for the economy.
In RBI, there are 2 types of rates that are prevalent in the economy and are used as a mechanism for formulating monetary policies. These two rates are:
- Repo Rate
- Reverse Repo Rate
Let us now understand what exactly these rates are and how they are used as a tool for formulating monetary policies in context of Indian economy.
Repo Rate is short form of “Repurchase Rate” which means the rate at which commercial banks borrows funds from the Reserve Bank of India. In simple terms it can be explained as: When individuals are in need of money they approach banks and take loan to satisfy their immediate monetary needs. In the same way when the commercial banks are in need of money, they approach the Reserve Bank of India and borrow funds from them. But these funds are borrowed by selling off government securities to the Reserve Bank of India. So the “Repo Rate” is the rate at which the commercial banks borrow money from the Reserve Bank of India in exchange of selling their securities. This credit taken by bank is usually of short term duration in nature.
Example: If Reserve Bank of India has set the Repo Rate at 5% and if any commercial banks borrow Rs.100 from Reserve Bank of India, then the commercial bank has to pay Rs.5 as the interest..
Reverse Repo Rate
Reserve Repo Rate is the rate where banks safe keep their surplus funds with the Reserve Bank of India and earn interest on these surplus funds.
Example:If Reserve Bank of India has set the Reverse Repo Rate at 5% and if any commercial bank has parked its surplus fund of Rs.100 with the Reserve Bank, then the bank will get Rs.5 as an interest on the amount that it has kept as surplus with the RBI.
Now that we have learnt about repo rate and reverse repo rate let us now understand how these rates help in formulating policies for the economy.
We have heard or read in the newspaper that Reserve Bank of India has slashed its rates or there is always a very detailed discussion by the financial pundits over the prevalent rates and possible rate cuts expected in the economy. So let us learn more about these Rates and Rate Cuts and their possible implications.