Financial Management Report

On
“Repo rate and impact on GDP”

SUBMITTED BY:
Mehak bhatia
Enrolment no. 21BSP0898

SUBMITTED TO:
Prof. PRAPTI PAUL
 Acknowledgement
I would like to express my special thanks of gratitude to my teacher prof. Prapti Paul who
gave me this golden opportunity to do this wonderful report on topic repo rate and its impact
on GDP, which also helped me in doing a lot of research and i came to know about many
terms related to it. With all my efforts and hard work, I have completed this report within the
prescribed time given to me.
 Abstract
The main purpose of this report is to study the repo rate and reverse repo rate as a monetary
policy instrument and its impact on GDP. This report analyses the changes taking place in
the repo rate for the period 2019-2021. Monetary Policy refers to a policy introduced by the
Central Bank or monetary authority to control money supply with an overall objective of
maintaining price stability and promotion of economic growth. Since, independence, the RBI
has been using different policy instruments to achieve the objectives of monetary policy.
During the period 1951-1990, the RBI has been using Bank rate, CRR and SLR for achieving
the objectives. During 1990s, when the government of India initiated economic reforms of
liberalisation, privatisation and globalisation, bank rate was still considered and used as a
significant monetary policy instrument. But, with the recommendations of Narsimhan
Committee, Repo Rate went on to become the most significant monetary policy instrument in
India’s Monetary Policy.
 INTRODUCTION
Monetary policy of India is under the domain of the Reserve Bank of India (RBI) with
government playing only an advisory role in its formulation and decisions. The RBI makes
major announcements regarding the monetary policy pursued by it twice a year i.e., one, in
the month of April or May and other in the month of October or November. Whenever, such
announcements are made, they are intended to give out indications regarding the stand taken
by the central bank with regards to monetary and credit policy.
During April 1997, the practice of automatic monetisation by issuing ad-hoc treasury bills
was completely eliminated. Subsequently, the RBI introduced the concept of ‘multiple
indicator approach’. In this approach, apart from broad money, a number of macro-economic
indicators such as rate of returns in different markets, currency, credit given by banks and
financial institutions, fiscal position, capital inflows, trade, rate of inflation, exchange rates,
refinancing and transactions in foreign exchange were considered and analysed in the process
of formulation of monetary policy. On the recommendations of Narsimhan Committee on
banking sector reforms (1998), the RBI introduced an Interim-Liquidity Adjustment Facility
in April 1999. As per the policy measures announced in June 2000 a full-fledged Liquidity
Adjustment Facility was introduced by the RBI. Later on, revisions were made in the years
2001 and 2004. On October 2004, a revised scheme of LAF was announced and international
usage of terms was adopted. Since then, Repo rate has become key policy rate of RBI’s
monetary policy.
1. Repo:
Repo stands for ‘repurchase option’ or ‘repurchase agreement’. It is a secured way of
raising short term capital that allows banks or financial institutions to borrow money from
other banks or financial institutions against government securities with an agreement to
buy those securities back after a specified time period and at a predetermined price
(which is higher than the initial sell price).The duration of these loans generally varies
between one day to a fortnight. In this system, the borrower enters into a repo or
repurchase agreement, whereas, for the lender, it’s a reverse repurchase agreement or
reverse repo. RBI uses repo and reverse repo to maintain economic stability in the
country.
2. CRR and SLR:
Cash reserve ratio or CRR is a portion of a commercial bank’s total deposits that needs to
be maintained at the central bank of the country (which is RBI in India). The limit of
CRR to be maintained is also determined by RBI. However, here the deposit is in the
form of liquid cash and has to be kept in an account with the RBI. Banks are not allowed
to utilise the CRR deposited for giving out loans or for other lending purposes. Apart
from that, CRR deposits are also not eligible for earning interests. CRR helps in ensuring
that the bank always has enough cash to disburse when depositors need it. The purpose of
this monetary policy is to check inflation in the economy. When CRR is increased, the
cash reserves of commercial banks are depleted which limits their lending capacity. This
reduces borrowings and helps in controlling inflation.
Statutory liquidity ratio or SLR refers to the minimum percentage of deposits that needs
to be maintained by commercial banks in the form of liquid assets, cash, gold,
government securities, etc. SLR is essentially a portion of the bank’s Net Demand and
 Time Liabilities (NDTL) or total demand deposits and time-based deposits. Just like
CRR, the limit of SLR for commercial banks is also decided by the central bank of the
country (Reserve Bank of India or RBI in India) but the deposits are maintained by the
respective banks themselves.
However, the SLR cannot be used by the bank for lending. The deposits designated
towards SLR are eligible for earning interests. This monetary policy of the RBI is aimed
at ensuring the solvency of the banks or ensuring that the banks, at any point in time, are
capable of paying back their liabilities. When there is inflation, RBI increases the SLR to
restrict the lending capacity of the bank. And when there is a need to infuse cash into the
system, RBI reduces the SLR to help banks offer loans at better rates and improve
borrowings.
3. Repo Rate and Reverse Repo Rate:
Repo rate is the most effective and efficient tool used by the Reserve bank of India(RBI)
to regulate country’s money supply, inflation and liquidity. In India, the Reserve Bank of
India or RBI (which is the central bank in the country) lends money to commercial banks
with an interest rate which is called repo rate. This interest rate is also applicable when
RBI borrows money from commercial banks. RBI uses repo and reverse repo to maintain
economic stability in the country. The levels of repo have a direct impact on the cost of
borrowings for banks. Higher the repo rate, higher will be the cost of borrowings for
banks and vice versa. On 4 April 2019, the Monetary Policy Committee (MPC) of the
Reserve Bank of India (RBI) revised the repo rate. This rate was decreased by 25 basis
points, from 6.25% to 6%. Even the reverse repo rate saw revisions with a decrease of 25
basis points, which then stands at 5.75%.

REPO RATE BY RBI

Repo rate is the rate of interest at which commercial banks in India borrow money from the
Reserve Bank of India. Commercial banks are required to deposit securities such as
government bonds or treasury bills as collateral to avail these loans from the central bank of
the country. These are generally short-term loans that banks take when there is a shortage of
cash. These loans are sanctioned in exchange for securities to help the banks achieve their
financial goals. Repo Rate is also known as benchmark interest rate. The origin of Repo rate,
one of the most significant components of Liquidity Adjustment Facility (LAF) can be traced
to United States of America (USA) as early as 1917 when the wartime taxes made other
sources of lending unattractive. Narsimha Committee on Banking Sector Reforms (1998) was
the basis of introducing LAF by the RBI in June 2000. Repo and Reverse Repo rates were
announced separately till the monetary policy statement of 3rd May, 2011. In these
statements, it was decided that the Reverse Repo rate would be linked with the Repo rate and
it will 100 basis point i.e., 1% below the Repo rate. The difference between the Repo rate and
Reverse Repo rate has been around 100 to 300 basis point. At present, the difference is only
around 25 basis points.
Reserve Bank of India (RBI) makes changes in the Repo rate according to the changing
macroeconomic factors. Whenever RBI modifies Repo rate it impacts all the sectors of the
economy, this is the key reason behind RBI using Repo rate as a policy instrument.
a. Impact of reduction in repo rate:
 Whenever Reserve Bank cuts the Repo rate, banks can borrow money at a cheaper rate
from the RBI. This impacts the lending capacity of commercial banks. Bank loans are
available at cheaper rates to the consumers. This leads to increased liquidity in the market
as well as increase in overall consumption of the economy. Whenever the RBI reduces
the Repro rate, it means the commercial banks can borrow money from RBI at a much
lower rate of interest. The commercial banks usually pass on this benefit on to their
customers by reducing the interest rates on loans. When interest rate is reduced, we pay
lesser amount of interest. This in turn brings down the overall cost of our loan. As a
result, the demand for loans rises from customers and positively impacts aggregate
demand. However increased liquidity can also lead to increased inflation. This is why
Repo rate cut usually occurs in relatively smaller amounts such as 25 basis points.

b. Impact of increase in repo rate:

Repo rate is also called as Market lending rate. Whenever Reserve Bank of India
increases Repo rate, borrowing becomes expensive for commercial banks. As borrowing
becomes costly for commercial banks, it affects their lending capacity. As a result,
commercial banks increase the rate of interest on loans which they offer to their
customers. This leads to a reduction in money supply and reduces liquidity in the
economy. Decrease in liquidity brigs down the inflation. During high levels of inflation,
RBI takes many steps to decrease money supply in the economy. During present times,
the most sought-after method is by increasing the Repo rate. However, increase in Repo
rate can also adversely affect economic growth due to decrease in consumption resulting
from lower money supply in the economy.

REVERSE REPO RATE

RBI also has provisions for banks to park their excessive funds for which RBI pays interest,
which is determined by reverse repo rate. This interest rate is also applicable when RBI
borrows money from commercial banks. RBI uses repo and reverse repo to maintain
economic stability in the country. When there is a need for an economic boost, RBI pumps
funds into the system by helping commercial banks borrow money from the bank. Using
repo, banks raise the necessary capital to increase their lending capacity. This ensures
liquidity for the bank and proper cash flow into the market. But, in the case of inflation, RBI
uses reverse repo to absorb funds from the market to regulate the lending capabilities of
commercial banks. Reverse repo rate is generally lower than the repo rate.

PROBLEM STATEMENT
Repo rate has become the most important tool of monetary policy pursued by the RBI in
recent times. It has been observed that any changes made in policy rates have significant
impact in economic growth in India. Changes made in Repo rate have a direct impact on
banking sector and its lending capacity. In recent years, the government, the banking sector,
the industry and even the general public seems to be very interested in the review of
monetary policy done by the RBI twice a year. Hence, the present study is an attempt to test
the impact of changes in Repo rate announced by the RBI on Quarterly growth rate of GDP at
current prices.
 CHANGES IN THE REPO RATE
Reserve Bank of India (RBI) makes changes in the Repo rate according to the changing
macroeconomic factors. In a bi-monthly monetary meet held on April 7, 2021, RBI
announced that the current repo rate has been kept at 4% and the reverse repo rate at 3.35%.
This is the fifth time in a row that these crucial rates haven’t been revised. In May 2020, the
repo rate was reduced by 40 basis points from 4.4% to 4% and the reverse repo rate was
made 3.35%.Repo rate and reverse repo rate are monetary policies used by RBI to maintain
economic stability in the country. Suppose the country is going through a cash crunch. In this
case, RBI will reduce the repo rate to help banks borrow more and make loans available to
the public at reduced rates. Now, if the country’s economy is experiencing inflation, RBI will
increase the reverse repo rate to limit borrowings by commercial banks. This, in turn, will
reduce their lending capacity and keep inflation in check.
Repo rate expected to remain unchanged in fiscal 2022
Reserve Bank of India's repo rate is expected to remain unchanged during FY22, said Emkay
Global in a report. A lower repo rate, or short-term lending rate for commercial banks, will
reduce the interest cost on automobile and home loans, thereby ushering in growth. However,
lower repo rate might trigger inflation as well.
Earlier this month, the Monetary Policy Committee (MPC) of the central bank voted to
maintain the repo rate, or short-term lending rate, for commercial banks, at 4 per cent.
Likewise, the reverse repo rate was kept unchanged at 3.35 per cent, and the marginal
standing facility (MSF) rate and the 'Bank Rate' at 4.25 per cent. The MPC outcome was
widely expected as India suffers from a massive spike in Covid-19 infections.
"We do not see any rate actions in FY22. We reckon RBI's focus on keeping the term premia
low will gather pace as global financial conditions might start to tighten gradually through the
year," said Madhavi Arora, Lead Economist, Global Financial Service in the report. "We also
expect core inflation to remain high, outdo headline and average comfortably above 6 per
cent in FY22. That said, RBI may still take solace in the fact that headline inflation may still
average sub 6 per cent in FY22 and thus could justify their policy accommodation." On bond
yields, she cited that in the near term, 'we are neutral on bonds amid the central bank's active
support anchored at the benchmark 10-year paper'. However, we do see yields inching up in
an orderly and gradual fashion in H2FY22. "We expect the yield curve to bear-flatten and see
benchmark 10-yr yield in the range of 6-6.40 per cent for the remainder of FY22.
Major differences between Repo Rate and Reverse Repo Rate
Besides the way these rates work, there are other differentiators which includes:
 A high repo rate helps drain excess liquidity from the market, whereas a high reverse
repo rate helps inject liquidity into the economic system.
 The repo rate is always higher than the reverse repo rate.
 Repo rate is used to control inflation and reverse repo rate is used to control the money
supply.
To conclude, the major difference between these two is that an increase in the repo rate will
make commercial banks borrow less. Whereas an increase in the reverse repo rate will allow
commercial banks to transfer more funds to RBI, which contributes to the money supply.
 IMPACT OF REPO RATE ON INDIAN ECONOMY
Repo rate is a powerful arm of the Indian monetary policy that can regulate the country’s
money supply, inflation levels, and liquidity. Additionally, the levels of repo have a direct
impact on the cost of borrowing for banks. Higher the repo rate, higher will be the cost of
borrowing for banks and vice-versa.

a. RISE IN INFLATION: During high levels of inflation, RBI makes strong attempts to
bring down the flow of money in the economy. One way to do this is by increasing the
repo rate. This makes borrowing a costly affair for businesses and industries, which in
turn slows down investment and money supply in the market. As a result, it negatively
impacts the growth of the economy, which helps in controlling inflation.

b. INCREASING LIQUIDITY IN THE MARKET: On the other hand, when the RBI
needs to pump funds into the system, it lowers the repo rate. Consequently, businesses
and industries find it cheaper to borrow money for different investment purposes. It also
increases the overall supply of money in the economy. This ultimately boosts the growth
rate of the economy.

IMPACT OF REPO RATE ON GDP:

Changes in the repo rates can directly impact big-ticket loans such as home loans. The
decrease in repo rates is to aim at bringing in growth and improving economic development
in the country. Consumers will borrow more from banks thus stabilizing the inflation. A
decline in the repo rate can lead to the banks bringing down their lending rate. This can prove
to be beneficial for retail loan borrowers. However, to bring down the loan EMIs, the lender
has to reduce its base lending rate. As per the RBI guidelines, banks/financial institutions are
required to transfer the benefit of interest rate cuts to consumers as soon as possible.
Whenever there is a change in macro-economic factors, the RBI considering all major and
minor factors brings about a change in policy rates i.e., Repo Rate, CRR, SLR and Bank Rate
as per requirements. Whenever, there is a change in policy rates it affects many sectors of the
economy in many different ways. In order to give an upward push to a stagnant economy, the
RBI brings about a reduction in Repo rate and in order to control inflation in the economy
rising above a nominal level, the RBI brings about an increase in Repo rate. Changes in Repo
rate have a string influence on market interest rates in the economy. There is no direct and
binding linkage between the Repo rates and banks’ lending or deposits rates but definitely has
a strong indirect influence. When the RBI is lowering the Repo rate it is sending a strong and
clear signal that the banks’ lending rates must go down and vice versa. When the banks
reduce the lending rates, it is called transmission of interest rate changes. As a result, there is
increase in lending, increase in money supply, increase in demand and resultant increase in
GDP.
 CONCLUSION
In a nutshell, the major difference between these two is that an increase in the repo rate will
make commercial banks borrow less. Whereas an increase in the reverse repo rate will allow
commercial banks to transfer more funds to RBI, which contributes to the money supply.
Also, it indicates that the changes in Repo rate led to a change in Gross Domestic Product
(GDP). Thus, Changes in Repo rate has significant impact on growth rate of GDP. There are
other several factors that also affect growth rate of GDP. Further analysis of impact of other
factors on the growth rate of GDP is hence called for.
 BIBLIOGRAPHY
https://economictimes.indiatimes.com/definition/Repo-rate
https://www.bankbazaar.com/finance-tools/emi-calculator/repo-rate-vs-reverse-repo-
rate.html
https://www.business-standard.com/article/economy-policy/repo-rate-expected-to-
remain-unchanged-in-fiscal-2022-emkay-global-121061900852_1.html
https://cleartax.in/s/repo-rate