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The Reserve Bank of India controls the money supply in the economy using the repo rate. It is the rate at which the RBI offers short term loans to financial institutions.
How the rate influences the economy?
The RBI uses the repo rate to control inflation and stabilise the economy in the following ways –
- During deflation, RBI attempts to reduce the money supply in the economy by increasing this rate. As a result, all financial institutions reduce their borrowings from the RBI. The outcome is a slowdown of investments and money flow in the economy as financial service providers increase the interest rates which automatically reduces end-user demands the availability of liquid funds.
- A reduction in the RBI repo rate occurs when the economy requires more money supply. It increases the lending capacity of the financial institutions as they can borrow additional funds from the Reserve Bank of India.
Benefits from a reduction in rates of interest
Recently, the RBI slashed its repo rate from 5.40% to 5.15%. One should know what to expect from the RBI repo rate cut announcement by referring to the following points -
- Reduction in this rate implies that financial institutions can provide loans at an easier interest rate to their customers. A borrower can avail the benefits of reduced EMIs on a home loan if it is a RLLR-linked loan.
- RBI repo rate cut boosts the industrial sector. It induces industries to avail more loans at nominal rates from financial institutions.
To conclude, this monetary policy of the RBI acts as a great tool in regulating the money market in adverse circumstances.
Must Read: - Consequences of a Repo Rate cut
