Sunday, 2 February 2014

1273505, Anamika Gupta, F1,Q5. Increase in Repo Rate? Pros and cons in current scenario?

Meaning of  Repo Rate

The rate at which the RBI lends money to commercial banks is called repo rate. It is an instrument of monetary policy. Whenever banks have any shortage of funds they can borrow from the RBI.  A reduction in the repo rate helps banks get money at a cheaper rate and vice versa.

When repo rate increases
§  Banks lend from RBI at a higher rates of interest
§  They lend it to borrowers at a high rate of interest
§  As lending interest rate increases, borrowing of money decreases
§  Increase in the deposit interest rate to attract depositors
When repo rate decreases
§  Increase in money supply in economy
§  Increase in demand of goods
§  Increase in GDP growth

 

Ø Significance of  Repo and Reverse Repo Rates?
In case of an inflation, RBI will try to reduce the amount of money in circulation by increasing the repo Rate. When repo rates are increased, banks will borrow less from RBI and hence the amount of money they will be lending to the public also decrease. In case of a deflation, RBI will want to inject more money into circulation and hence they will reduce the repo rate.
    Increase in repo rate can have serious impact on the growth since industries will find it difficult to raise money from the banks. Therefore bank rates are only increased when rate of inflation become too high and that too only for a short period.

·         Increase in Repo rate

Reverse Repo rate is the rate at which RBI borrows money from the commercial banks. The increase in the Repo rate will increase the cost of borrowing and lending of the banks which will discourage the public to borrow money and will encourage them to deposit. As the rates are high the availability of credit and demand decreases resulting to decrease in inflation.

·         RBI raises repo rate by 25 bps to 8 per cent

The repo rate, at which banks borrow short-term money from RBI, was raised by 25 basis points, or 0.25 percentage point, to 8 per cent. The reverse repo, at which RBI borrows from banks, was raised 25 basis points to 7 per cent. The marginal standing facility, the penal rate of interest for banks, was raised 25 basis points to 9 per cent to maintain the corridor. The cash reserve ratio was unchanged at 4 per cent.

·         Effects of Repo rate on Inflation
When the repo rate is raised, banks are compelled to pay higher interest to the RBI which in turn prompts them to raise the interest rates on loans they offer to customers. If the availability of funds is scarce, and banks are not able to borrow at repo rate, they may have to increase the deposits rates upwards to attract depositors. Hence, any rate hike in repo rate increases the probability of higher deposit rates, which is good news for depositors.
·         Impact on Sectors
Sectors such as automobiles, consumer durables and realty are the most vulnerable in the scenario where policy rate hikes push the interest rates. Rising rates would not only reduce the demand for these companies’ products, they will also affect their earnings in terms of rising interest costs. Rising rates would also impact companies with higher leverage.
·         Impact on borrowers
Due to the current rate hike, the worst affected are home loan borrowers who are servicing the loan under floating interest rate as the lenders have the power to increase the rates of interest on the basis of its base rate for their floating rates.
·         Impact of hike in repo rate to common men and economy
This hike in repo rates are passed on by the banks inform of increase in borrowing rate to common men. So, cost of auto, education, home and personal loans will increase correspondingly. Loans to companies for its operations also increases which led to decline in borrowings. These factors penalize Indian industry which has already slowed down.











Ø Pros and Cons of Raporate in Current Senario
Pros
This tool is a quick fix for woes of economy and brings in results very fast. The higher the number goes, less money is available in economy and inflation goes down. The lower this number and more money will be available in country to enable it to go on growth path.
Cons
The change in this number affects both growth rate and inflation of economy. If this number is raised, inflation reduces, and growth also reduces. So this tool should be used with extreme caution.

RBI rate hike will check inflation: C Rangarajanhttp://articles.economictimes.indiatimes.com/images/pixel.gif

PTI Jan 28, 2014, 04.41PM IST
NEW DELHI: The Reserve Bank's hiking the key lending rate by 0.25 per cent is a reflection of its "strong commitment" to check inflation, Prime Minister's Economic Advisory Council (PMEAC) Chairman C Rangarajan said on 29/1/2014 .
"This is a reflection of the strong commitment of Reserve Bank to the price stability as the chief objective of the monetary policy. I think the decision also reflects certain change in terms of the indicators that they are monitoring," Rangarajan said post RBI's third quarter monetary policy . "...it is also indicated that perhaps if inflation moves along the direction expected, perhaps this may be the last in the series of increasing in the policy rates," he added. Rangarajan said the RBI decision to raise to 8 per cent the repo rate, at which it lends to banks - also reflects certain change in terms of the indicators monitored by them.
"While the Wholesale Price Inflation (WPI) remains near the comfort zone, the Consumer Price Inflation (CPI) is not. Therefore the decision to increase the interest rate is once again reflection of the shift in terms of the focus from wholesale price inflation to retail inflation," he added. Retail or CPI inflation in December had moderated to a three month low of 9.87 per cent, while the wholesale or WPI was at 5-month low of 6.16 per cent. NainaLalKidwai, the Country Head, India Operations of HSBC Bank said the monetary policy decision of RBI will see the "inflation responding for a change".
"The concern, of course, remains on food prices. We have not yet had enough action on some moves to ensure that food inflation comes down. But, of course we need to continue to see investment. The biggest worry is growth," she said. Expressing no surprise over the RBI decision to hike the repo rate - the rate at which the RBI lends money to commercial banks - Head of Research, Standard Chartered Bank Samiran Chakraborty hoped there will be no further rate hike.
"Rate hike is not a complete surprise. The Urjit Patel Committee clearly focuses on headline inflation. We could have seen the rate hike in December as well... At this moment, I am not expecting any further rate hike," Chakraborty said. Replying to a question on the impact of rate hike on growth, Rangarajan said that it will be higher than what RBI has projected.
"I think the growth rate will be somewhat higher than what they are projecting. I expect the growth rate for the current year itself to be around 5 per cent. And perhaps the pickup in the growth in the next year will be somewhat higher than what they have indicated. I think that the growth rate next year could be in the range of 6-6.5 per cent," Rangarajan said. In its review, the RBI has projected the GDP growth to be less than 5 per cent in current fiscal. For next fiscal beginning April 1, 2014 it has projected growth to improve to 5.5 per cent.
Suggestion:I do not think there was a need to raise the rate. This step by RBI would encourage banks to raise their lending rates, thereby impacting buyers’ decisions. RBI should understand that without a flexible credit facility, it will be difficult for many sectors to grow. It will also affects individual and  Indian economy. As the lending rates increase and the liquidity crunch prevails, will generally tend to economic slowdown. However the RBI and the govt. must try to find out better ways to balance the rising inflation and economic growth of the country.

Conclusion: Increase in rapo rate is good for some but bad for many.Due to increase in the repo rates by the central bank (RBI), the banks are going to increase the primary lending rates which will be generally ranging from loans for homes, automobiles and even study loans. Main objective of  increase in rapo rate is to control the inflation rate.

No comments:

Post a Comment