The Reserve Bank of India (RBI) recently hiked the repo and reverse repo rates by 25 basis points each. When banks face any shortfall of funds they borrow from the central bank. The repo rate is the rate at which banks borrow money from the RBI. If the RBI reduces the repo rate, it will be cheaper for banks to borrow money. On the other hand, if repo rate goes up, borrowing becomes expensive.
Currently, the repo rate has been hiked from 5.25 to 5.50 percent. The RBI can borrow money from banks and offer them a lucrative rate of interest. This is called the reverse repo rate. When the reverse repo rate is increased banks find it more attractive to have their money with the RBI, and hence money is drawn out of the system. The reverse repo rate, which is the key borrowing rate, has been increased from 3.75 to four percent.
Reasons for hike
The central bank justified its policy decision as a move to 'contain inflation and anchor inflationary expectations going forward, while not hurting the recovery process'. Inflation is a rise in the general level of prices of goods and services in an economy over a period of time. While the Wholesale Price Index (WPI) based inflation in double digits is a concern, food price inflation is an immediate cause of worry.
With prices of food articles touching the roof and cost of vegetables crawling upwards, inflation needs to be tackled head on. The impact of increase in fuel prices will be felt in the months ahead. It is bound to increase inflationary pressures. Agriculture growth is expected to be better than last year with unfailing monsoons. Manufacturing sector, capital goods and the over all economy has managed to pull itself towards recovery.
While the RBI has hiked the repo and reverse repo rates, it has kept the cash reserve ratio (CRR) untouched. The need for a huge sum of money by telecom companies for 3G mobile spectrum has drawn out liquidity from the system. This is attributed as the reason for not hiking the CRR.
Impact on borrowers
Most banks have decided against passing on this hike to borrowers. The CRR is the portion of funds that banks have to retain with the RBI. When the RBI increases this percentage, the amount actually available with the commercial banks comes down. The RBI increases the CRR to draw out excessive money from the banking system and thus checks increase in prices.
Many analysts predict another round of rate hikes to be announced by the RBI. Keep a track of the liquidity in the system that could finally be the deciding factor. For now, borrowers who are already battling high food, grocery and fuel expenses, have nothing to worry on home loan repayments.
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