Context: RBI’s Monetary Policy Committee has decided to cut the repo rate by 25 basis points to 6%. The decision comes amidst heightened global economic uncertainty in the face of reciprocal tariffs announced by the US.
MPC has slashed the GDP growth to 6.5% in FY26 from 6.7% projected earlier. Retail inflation is expected to be 4% in FY26.
Relevance of the Topic:Prelims: Repo Rate; Reverse Reo Rate.
Repo Rate and Reverse Repo Rate
- Repo Rate: The interest rate that the RBI charges when commercial banks borrow money from it.
- Reverse Repo Rate: The interest rate the RBI pays commercial banks when they park their excess cash.
Reduction of Repo Rate: Promotes Economic Activity
- When the RBI wants to encourage economic activity in the economy, it reduces the repo rates.
- This enables commercial banks to bring down the interest rates they charge (on their loans) as well as the interest rate they pay on deposits. Interest rates on home, personal, vehicle loans and deposit loans come down.
- This incentivises people to spend money as keeping their savings in the bank pays back a little less interest.
- Businesses are incentivised to take new loans for new investments as new loans now become cheaper.
Increase in Repo Rate: Control Inflation:
- When the RBI wants to control inflation, it increases the repo rate.
- Banks charge more interest to their borrowers, as they have to pay more interest to borrow from the RBI.
- At a macro level, this inhibits people from borrowing money as well as from spending, which in turn reduces the amount of money in the market, and thus negates inflation.
Repo and Reverse repo rates are often referred to as the “benchmark” interest rates in the economy. Using these rates, the RBI sets the tone for all other interest rates in the banking system, and in the broader economy.