Repo, which is short for ‘Repurchase Agreement,’ is a financial arrangement where banks pledge eligible securities, such as Treasury Bills, to the RBI in exchange for overnight funds. This agreement includes a commitment to repurchase the securities at a predetermined price. As a result, the bank gains liquidity while the central bank holds the securities as collateral.

The repo rate is the interest rate at which commercial banks take or borrow money from the Reserve Bank of India. The RBI loans money to commercial banks in exchange for any government securities.

Period wise changes in Repo rate is shown by the graph and table mentioned below:

– What is Meant by Reverse Repo Rate?

Reverse Repo Rate is when the RBI borrows money from banks when there is excess liquidity in the market. The banks benefit out of it by receiving interest for their holdings with the central bank.

In times of high inflation, the Reserve Bank of India (RBI) raises the reverse repo rate. This encourages banks to deposit more of their surplus funds with the RBI, as they can earn higher returns on these funds. As a result, banks have less liquidity available to lend to consumers or businesses, effectively reducing the overall money supply in the economy. This helps curb inflation by limiting excessive spending and borrowing.

– Current Repo Rate and its Impact

The Reserve Bank of India (RBI) regularly adjusts the repo rate and reverse repo rate to respond to changing macroeconomic conditions. These adjustments have far-reaching effects across various sectors of the economy, with some benefiting from rate increases while others may face challenges. In the Monetary Policy Committee (MPC) meeting on 7th February 2025, the RBI reduced the repo rate by 25 basis points to 6.25%, after holding it steady at 6.5% for the past two years. The reverse repo rate, however, was left unchanged at 3.35%.

The RBI’s decision to reduce the repo rate is aimed at stimulating economic growth and promoting investment. By lowering the repo rate, borrowing costs decrease for both businesses and individuals, making it easier to access credit and encouraging higher spending. This strategic move is intended to drive economic expansion while maintaining control over inflation.   

A reduction in the repo rate often leads banks to lower their lending rates, which can be advantageous for retail loan borrowers. Adjustments in the repo rate also have a direct effect on large loans, such as home loans. However, to lower loan EMIs, lenders must reduce their base lending rate. According to RBI guidelines, banks and financial institutions are required to promptly pass on the benefits of interest rate cuts to consumers.

Thus, the rate cut helps banks lower their lending rates, making credit accessible and affordable for borrowers, which in turn will increase borrowing, spending, and investment, ultimately supporting job creation and employment.

Lower interest rates can lead to higher asset prices, including stocks. This often makes investors more confident in making longer-term capital investments, knowing the cost of borrowing is lower, and that businesses may benefit from the lower-cost environment.

– How Does Repo Rate Affect the Stock Market?

Interest rates and the stock market are inversely related. Every time the Central Bank raises the repo rate; the stock markets are immediately affected.

This means that the increase in the repo rate causes businesses to reduce their expenditure on expansion, which slows down growth, has an impact on profits and future cash flows, and causes stock prices to drop. Conversely, when the repo rates are reduced, the cost for business expansion reduces thus positively impacting the profits and future cash flow and thereby cause the stock prices to rise.

While repo rate hikes generally lead to market corrections, sometimes markets react positively if the rate hike is seen as a measure to control inflation. Thus, an inverse relationship exists in principle, but the actual market reaction depends on broader economic conditions along with other factors.

Conclusions:

For businesses, the reduced repo rate can encourage investment and expansion by making financing more affordable. However, the RBI must balance this with the need to control inflation. While the rate cut aims to boost economic activity, it also carries the risk of increasing inflationary pressures. Therefore, the RBI will need to monitor economic indicators closely to ensure that the benefits of stimulating growth do not lead to undesirable inflation levels.

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The article is authored by Mr. Nikhil Nagdev from Team RichVik.