Saturday Brain Storming Thought (253) 14/12/2024
REPO RATE
The Repo Rate is the interest rate at which the Reserve Back of India (RBI) loans money to commercial banks
Banks obtain loans from RBI by selling qualifying securities
Current Repo Rate in India
The current Repo Rate in India has been fixed at 6.50% as per announcement made by the government on 08/08/2024
Impact of Repo Rate Hike on various aspects
1) Impact on Economic Growth
a) Due to the rise in Repo Rate, people may purchase increasingly fewer goods and services, which affect potential growth ie slow growth
b) Goods and services become expensive and may no longer be within the means of underprivileged sections of society
c) Unplanned negative effect on economic growth, may lead to inflation
2) Impact on Inflation
a) To combat inflation, this might occur Inflation-growth scenario does not improve
b) Inflation is anticipated to tone down due to these price increases
c) The economy is approaching a peak and the likelihood of further RBI repo rate hikes is low
3) Impact on Loans and EMIs
a) Banks raise interest rates, existing borrowers may experience a rise in EMIs even more
b) Repo Rate hikes affect all types of loans, including mortgages, vehicle loans, personal loans, business loans, credit cards and everything along the same line
b) Borrowing money from commercial banks becomes more expensive
c) Lowers down the consumption of goods and services due to unaffordability
d) Influences both the supply and demand chain
4) Impact on Deposits and Fixed Deposit Rate
a) Customers having short and medium term investments like FD and savings, might benefit and they will receive higher returns
b) The dissemination of the interest rate increases, being a little slower
c) Banks will eventually raise interest rates on deposits
5) Impact on Mutual Funds
a) Investors in Mutual Funds should exercise caution for hike in Repo Rate
b) Toughening interest rates can stifle investor confidence in the debt and stock market
c) Long term bond prices decline as yield increases, which lowers the return on debt investments
d) Debt investors are compelled to withdraw their funds
e) Debt funds may therefore experience short to medium term volatility
6) Impact on Savings
a) For such individuals having savings and fixed deposits, higher rates are advantageous
7) Impact on Consumer Spending
a) People are discouraged from taking large purchases when borrowing cost rises
b) Reduces the demand for goods and services
c) Fewer goods and services might be purchased negatively, affecting demands and requirements
d) Numerous goods and services might see price increase and eventually become out of reach for the less fortunate sections of society
Repo Transaction
The Repo Transaction comprises two phases
1) Phase 1 – Transaction for a nearer date
In this phase, the selling of the security and its repurchasing take place
The sale price is based on the available market price for outright deals
2) Phase 2 – Transaction for a future date
The price is determined based on the fund’s flow of interest and tax elements of funds exchanged
In terms of transaction, both phases are booked as spot sale/purchase transactions
Thus, after adjusting for accrued coupon interest, sale and purchase prices are fixed to yield the required repo rate
Repo Rate Calculation
Repo Rate = (Repurchase Price – Original Selling Price ÷ Original Selling Price) X (360 ÷ n)
Repurchase Cost = Original Selling Price + Interest
Original Selling Cost = Sales Cost of Security
n = Number of Days to maturity
Repo Period
1) There is no restriction on the maximum period for repos
2) It could be an overnight term, open or flexible, or it can be one week
3) Overnight repos last just one day
4) It is a term repo if it has a fixed period and an advanced agreement
5) There is no such fixed maturity period in an open repo
6) Under flexible repos, the lender places funds, but the borrower withdraws them as per requirements over an agreed period
Components of Repo Rate Transaction
1) Inflation
With the repo rate, the central bank keep inflation at its limit
2) Hedging and Leveraging
The primary goal of the RBI is to hedge and leverage
They buy securities bonds from commercial banks and provide them with cash in exchange for deposited securities
3) Short-term Borrowing
The Repo agreements are for a short period, and the RBI has clearly stated it
Commercial banks must buy back their securities at agreed upon prices and period
4) Collateral and Security Components
The RBI accepts collateral as bonds or gold in exchange for the lianed money
5) Cash Reserve
Commercial banks borrow money from the central bank to maintain their cash reserve or liquidity as a preventive action
Repo Rate working
1) Borrow money from RBI
2) On which they must pay interest
3) This interest rate is repo rate
4) Technically, Repo stands for Repurchasing Option
5) Banks provide eligible securities (Treasury Bills)
Importance of Repo Rate
1) Safer investment since security acts as collateral in this type of agreement
2) Maintain liquidity in the market
3) Checks inflation in the economy
4) Lower interest rate as compared to an unsecured loan
5) A reduced repo means the availability of loans at cheaper Interest rates
6) Lower interest rates are likely to reduce commodity prices, ultimately benefitting the end consumer
Frequency of Repo Rate changing
The frequency of Repo Rate changes varies from country to country and drpends on the central bank’s economic conditions and monetary policy stance
Repo Rate change can range from monthly to quarterly or even more frequently if necessary
Factors affecting Repo Rate
1) Inflation
2) Liquidity
3) Monetary policy
4) Growth in Economy
5) Uncertainty
COMPILED BY:-
Er. Avinash Kulkarni
9822011051
Chartered Engineer, Govt Regd Valuer, IBBI Regd Valuer
