A Comprehensive Guide to Repo Rate and How it Works

Have you ever noticed that sometimes home loans become more expensive, or that the interest on your Fixed Deposit changes, even though you didn't do anything differently? The reason behind these shifts often comes down to something called the repo rate, a key tool used by the Reserve Bank of India (RBI) to steer the economy. But don't let the term scare you—it's simpler than it sounds!

Imagine if understanding this one concept could help you make better decisions about borrowing money or saving for the future. In this article, we'll break down what the repo rate is in everyday language, show you how it affects everything from your monthly loan payments to the prices of goods in stores, and explain why keeping an eye on it can be beneficial for you. Whether you're new to financial topics or just want a clearer picture of how the economy works, this guide will offer insights without the complicated jargon.

What is Repo Rate?

Repo rate stands for Repurchase Agreement Rate. It is the interest rate at which commercial banks borrow money from the RBI against pledging government securities such as treasury bills or bonds. When banks face a shortage of funds, they can borrow from the central bank through repurchase agreements. These agreements involve selling securities to the RBI with an agreement to buy them back at a later date. 

What is the Current Repo Rate in India?

The current repo rate in India as on 26 November 2024 is 6.50%. The last time RBI had changed the repo rate from 6.25% to 6.50% was on 8th February 2023. Since then the repo rate has remain unchanged. Check out the table to understand the historical movements of repo rate.

Historical Repo Rates from 2010 to 2024

How Repo Rate Works?

• The process of borrowing money begins when commercial banks contact the central bank to borrow money and present government securities as security.
• Central banks evaluate the request, authorise collateral, and disburse cash at the current repo rate.
• Interest rate or repo is applied to the borrowed amount, representing the commercial bank's borrowing cost.
• Following a predetermined time frame, the borrowing bank buys back securities from the central bank at a price covering the loaned amount and interest.

Significance of Repo Rate

The repurchase agreement rate plays a crucial role in controlling inflation and regulating economic growth. When the RBI increases the repo rate, borrowing becomes more expensive for banks. As a result, banks raise their lending rates, making loans costlier for individuals and businesses. This acts as a deterrent to borrowing and spending, reducing the overall money supply in the economy. Consequently, inflation is controlled as demand decreases.

On the other hand, when the RBI reduces the repo rate, borrowing becomes cheaper for banks. This enables them to lower their lending rates, encouraging borrowing and spending. Increased borrowing and spending stimulate economic growth by boosting consumption and investment. However, it's important to strike a balance between stimulating economic growth and managing inflation.

How Does Repo Rate Affect You?

Repo rate has a direct impact on your personal finances. When the repo rate increases, banks raise their interest rates on loans, making it more expensive for you to borrow money. Whether you're taking out a home loan, car loan, or personal loan, higher interest rates mean higher monthly EMIs (Equated Monthly Instalments).

1. Impact on Loans

   Suppose you've taken a home loan of ₹60 lakhs with a tenure of 20 years at an interest rate of 9%. If the repurchase rate increases by 0.5%, your bank may raise the interest rate on your home loan by a similar margin, resulting in increased EMIs by ₹2000. 

    

2. Impact on Savings Account

   If you have ₹2 lakh deposited in a savings account with an interest rate of 5% and the RBI reduces the repurchase rate by 0.50%, your bank may lower the savings account interest rate by a similar margin. As a result, you could see a decrease in your annual interest earnings by around ₹1000.

    

3. Impact on Fixed Deposits

   Say you invest ₹5 lakhs in a fixed deposit with a tenure of 3 years and an interest rate of 7%. If the repurchase rate increases by 0.25%, the bank may increase the FD rate, increasing the maturity amount.

    

How to Make the Most of Repo Rate Changes

Repo rate changes by the Reserve Bank of India (RBI) might seem distant, but they directly impact your finances—from loan interest rates to savings returns. Here’s how you can turn these changes into opportunities:

1. Stay Informed: Keep track of the rate announcements by following reliable financial news sources or staying updated with notifications from your bank. Understanding when repo rate changes occur will help you anticipate potential impacts on your loans and savings accounts.
2. Evaluate Loan Options: If you're planning to take a loan, consider comparing interest rates offered by different banks before making a decision. A small difference in interest rates can result in significant savings over the loan tenure.
3. Optimise Your Savings: When rates are low, take advantage of higher interest rates on fixed deposits and savings accounts to grow your wealth. Consider diversifying your savings across different products to maximise returns.
4. Review Existing Loans: If rates decrease significantly, it might be worth exploring options to refinance existing loans at lower interest rates. This could help you save money on monthly EMIs or shorten the loan tenure.
5. Maintain a Budget: Fluctuations in loan EMIs due to repurchase rate changes can affect your monthly cash flow. To ensure you're prepared for any such changes, maintain a budget that accommodates variations in EMI payments.

By understanding how repo rate affects different financial products and services, you can make informed decisions that align with your financial goals.

What is Reverse Repo Rate?

Both repo rate and reverse repo rate share similar purpose – to ensure economic stability. However, there are stark difference between the two. The reverse repo rate is the interest rate at which the central bank borrows money from commercial banks within the country. It serves as a key monetary policy tool used by the central bank to regulate the money supply and manage liquidity in the economy. The current reverse repo rate in India as on 26 November 2024 is 3.35%.

What is the Difference Between Repo Rate and Reverse Repo Rate?