Just after Mr. Raghuram Rajan was appointed as the governor of RBI the financial papers were filled with the headlines stating that RBI is going to increase the repo rate to curb inflation? That did sound Greek and Latin to us for we never really knew what exactly a repo Rate is ….What is a repo rate anyway?
Banks require keeping a portion of their deposits as cash with the Reserve Bank. What happens if the bank falls short of cash to deposit with the Reserve Bank they borrow from RBI pledging Government securities? Hence, Repo rate is the rate at which Reserve Bank lends money to banks and acts as an instrument of monetary policy and functions. Let’s go back to the headlines why did RBI increase the repo rate as a means to curb inflation?
So here it is when we know that the interest of a particular loan increases we are more likely to not consider the loan which in other words would mean the demand for these loans decreases. The reason why the reserve bank increased the repo rate is that it wants to make the cost of funds expensive for banks.
Therefore higher the cost of funds would lead to the economy being costlier which reduces the demand for loans that in turn leads to lower demand in goods and services. Now when there is a low demand for goods and services the producers are wise enough to not make the mistake of increasing the price of goods and services instead they will decrease the price for a higher demand of goods and services that in turn leads to decrease in inflation in the economy.
Wasn’t the repo rate mayhem that simple? Which is why it was indeed a good move to increase the repo rate.
– Khyati Kotiyan
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