Reasons Behind Increasing Repo & CRR Rate By RBI

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The most effective strategy, we believe, is to simultaneously announce changes to the policy that impact the rate and the amount of liquidity available. The RBI will not alter its policy stance when decreasing or increasing its repo rate and its Cash Reserve Ratio (CRR) in its anti-inflationary measures. Research has shown that a central bank's credibility can be maintained when the market responds positively to the bank's liquidity operations. So what are the actual reasons for hiking in Repo & CRR rates? let us find out -

What is the repo rate?

When you borrow any specific amount from a bank, you will be charged interest on the principal rate, and this is also known by the term "cost of credit." Likewise, banks take money from the RBI in the event of a cash shortage, in which case they have an order to repay interest back to the RBI, and this interest rate is known as the repo rate. The RBI raises repo rates in times of inflation. It increases the cost of borrowing cash from the central bank.
The following table lists the latest repo rates that have been maintained through the Reserve Bank of India in the past some years:

Historical Repo Rates in India

What is CRR (Cash Reserve Ratio)?

The cash reserve ratio (CRR) is typically described as an exact amount of money that needs to be held as a reserve for every commercial bank across India under the requirements of the RBI. The CRR will be set according to the regulations and rules of the RBI.
Under CRR, a certain proportion of bank deposits must be stored in the account currently of RBI. 
There are some important reasons CRR exists -

• CRR can help control inflation. If inflation is very high, CRR may be increased to deter the banks, not to lend more.
• CRR is also tied with the basic rate for loans, which is the rate at which banks cannot lend money. A base rate is a way to ensure that lending is transparent, and CRR acts as an appropriate reference rate for it.
• CRR is a method for controlling the amount in the market. If CRR is cut and lowered, it positively affects the economic system.

The reason "why the RBI raised its repo rates"?

RBI Governor Shaktikanta Das explained that raising the repo rate was made with them in mind rising inflation and tensions between the world's two major powers.

The main reason behind the repo rate being raised is to fight inflation. Inflation was 7 percent as of March and is predicted to rise even more when the April estimates are released.

According to the RBI, the ideal inflation goal is between 2% and 6%.

The inflation rate is being driven ahead by various reasons, most notably the increase in food prices and the cost of fuel.

"While the Indian economy can survive the Changement in geopolitical conditions resulting from the ongoing conflict between Ukraine and Russia. Our economy is facing challenges due to global spillovers resulting from geopolitical tensions, heightened prices for commodities, and the easing of external demand"-The RBI Governor stated on Wednesday, May 4, 2022.

It is also worth noting that the RBI Governor also said that food inflation is likely to continue to rise as consequences of global shortages of wheat are affecting the price of domestic wheat even though supplies in the domestic market remain sufficient. Because of the war between Russia and Ukraine, the price of edible oil could rise as major producers and countries have placed restrictions on exports.

What happened when the repo rate increased?

The rising repo rate is expected to force the banks and non-banking finance companies (NBFCs) to increase deposit and lending rates. That means the interest rates for loans will increase. Monthly installments based on equated monthly installments (EMIs) on an automobile, home, and other commercial and personal loans are likely to increase.

The rise in the repo rate could mean that people will be required to pay a more expensive interest rate if they apply for an unsecured home loan. But this is unlikely to significantly impact the market for home loans since other factors, such as the supply and demand of buyers, have a significant role in determining the rate.

How does a hike in repo rate and CRR Impact the Economy?

Effect of Repo Rate on Economy: 

• In periods of high inflation, RBI makes strong attempts to limit cash flow throughout the economy. One strategy to do this is to increase repo rates. This makes borrowing a more expensive process for both industries and businesses. This, consequently, reduces investment and reduces the quantity of the market. This could negatively impact growth in the economy and help in decreasing the rate of inflation.
• If the RBI must pump funds into the banking system, it decreases its repo rates. This means that businesses and industries can get less money to fund various investments. It also increases the amount of money that is available in the economy.

Effect of CRR on Economic:

CRR is the ratio between the cash reserves of commercial banks partnered with the reserve bank and their overall deposits. When inflation is high, CRR is increased, and an increase in CRR decreases the amount of high-powered money in commercial banks. It affects the capacity to create credit. As a result, demand for aggregates decreases to fix the inflation gap within the economy.

FAQs

Why does RBI increase the repo rate?

In the circumstance of rising inflation, the RBI increases repo rates to deter banks from borrowing money from the RBI, which reduces the amount of money available in the economy and helps to mitigate inflationary increases. The central bank typically is not in the same position when there is a drop in the inflation rate.

Why is CRR increasing?

When there is a high level of inflation, efforts are taken to limit money flow through the economy. To do this, RBI raises the CRR while decreasing the funds available for loans to the banks so that results turn out to slow down investment and lower the amount of money available in the economy.

What happens when the repo interest rate decreases or increases?

When the repo rate rises, the cost of money borrowing for companies rises, resulting in decreasing money flow and investment into the marketplace. However, when there is an economy experiencing a liquidity shortage, RBI reduces the repo rate, and consequently, borrowing costs are reduced, increasing cash flow into the economy.

Conclusion:

The changes in repo rates will directly impact loans with high costs like home loans. The drop in repo rates aims to increase the country's economic condition. Consumers will take out more loans from banks, which will help stabilize the rate of inflation. The latest policy decision will impact the totality of loans, whether for a home, a car, or personal loans. However, the RBI's decision could benefit people who invest their funds in Fixed deposits (FDs) and savings accounts since banks could offer higher interest rates for FDs.