Reverse Repo Normalisation

Why in news?

• In a recent report, State Bank of India has stated that it believes the stage is set for a Reverse Repo Normalisation in India.
• The Repurchase agreement (Repo) and the Reverse repo agreement are two key tools used by the Reserve Bank of India (RBI) to control the money supply.

What are Repo and Reverse Repo Rates?

• Repo rate is the rate at which the central bank of a country (RBI in case of India) lends money to commercial banks in the event of any shortfall of funds. Here, the central bank purchases the security.
• Reverse repo is the interest rate that the RBI pays to the commercial banks when they park their excess “liquidity” (money) with the RBI.

What is Reverse Repo Normalisation?

• It means the reverse repo rates will go up i.e. raising the reverse repo rate in one or two stages.
• In the face of rising inflation, several central banks across the world have either increased interest rates or signalled that they would do so soon.
• In India, too, it is expected that the RBI will raise the repo rate. But before that, it is expected that the RBI will raise the reverse repo rate and reduce the gap between the two rates.

Significance:

• The process of normalisation is mainly aimed at curbing inflation.
• However, it will not only reduce excess liquidity but also result in higher interest rates across the board in the Indian economy.
• Thus reducing the demand for money among consumers (since it would make more sense to just keep the money in the bank) and making it costlier for businesses to borrow fresh loans.

PRACTICE QUESTION

Which of the following statements is/are correct?

1. Repo rate is the rate at which the RBI lends money to commercial banks

2. During inflation RBI tends to reduce the reverse repo rate

Select the correct answer using the code given below:

(a) 1 only

(b) 2 only

(c) Both 1 and 2

(d) Neither 1 nor 2

Answer