Repo rate is the benchmark interest rate in our economy. Repo rate is the interest rate at which the Reserve Bank of India (RBI) lends money to commercial banks, in case there is a temporary shortfall in funds. If the repo rate increases, there is less incentive for banks to borrow money from the RBI. Repo rate hike therefore, reduces the amount of money supply (liquidity) in the banking system. RBI uses the Repo rate as a tool to control inflation. When inflation is high, RBI increases the repo rate to reduce money supply and control inflation. On the other hand, when economic activity declines and inflation is low, RBI has the ability to reduce repo rate, encouraging banks to lend to increase economic activity (GDP). Repo rate is the most important interest rate of our economy and forms the fundamental basis of interest rate setting for deposits and loans by banks.
