Written by This article explains the repo rate, reverse repo, bank rate, MSF, and SDF in detail with examples, highlighting their macro and microeconomic effects.
Why Is the Repo Rate in the News?
On February 7, 2025, the Reserve Bank of India (RBI) reduced the repo rate by 25 basis points, bringing it down from 6.5% to 6.25%. This is the first repo rate cut in nearly five years, with the previous reduction occurring in May 2020 during the COVID-19 crisis.
This decision comes as part of RBI’s efforts to stimulate economic growth while ensuring inflation remains under control. The central bank has projected GDP growth at 6.7% for FY 2025-26 and expects inflation to decline to 4.2% from the current 4.8%.
The repo rate cut has significant implications for the economy:
- For borrowers: Loan EMIs may reduce as banks lower their lending rates.
- For savers: Interest rates on deposits could decrease, making savings instruments less attractive.
- For businesses: Cheaper loans can encourage investment and expansion.
- For inflation: Lower interest rates can increase spending, which may put upward pressure on prices.
Read: Monetary Policy Statement by Reserve Bank of India
To understand the full impact, we need to examine the repo rate and other key monetary policy rates set by the RBI.
What Is the Repo Rate?
The repo rate (short for repurchase rate) is the interest rate at which commercial banks borrow money from the RBI by pledging government securities.
How It Works:
- A bank in need of funds sells government securities to RBI and agrees to buy them back at a later date at a higher price.
- The difference in price determines the repo rate, which acts as an interest cost for banks.
- When the RBI reduces the repo rate, borrowing becomes cheaper for banks, which in turn reduces interest rates for businesses and consumers.
Example:
- If a bank borrows ₹100 crore from the RBI at a 6.5% repo rate, it has to return ₹106.5 crore after one year.
- If the repo rate is cut to 6.25%, the repayment falls to ₹106.25 crore, making borrowing cheaper.
Impact on the Economy:
- Macro (Economy-Wide): Encourages borrowing and investment, boosting GDP growth.
- Micro (Individuals & Businesses): Reduces EMIs for home, car, and business loans.
Other Key RBI Rates and Their Significance
1. Reverse Repo Rate
Definition: The interest rate at which banks park their excess funds with the RBI.
Current Fixed Reverse Repo Rate: 3.35%
Impact:
- If RBI increases the reverse repo rate, banks prefer to keep money with RBI rather than lend, reducing liquidity in the market.
- If RBI lowers the reverse repo rate, banks lend more to businesses and individuals, increasing economic activity.
Example:
If a bank has ₹1,000 crore in excess funds and the reverse repo rate is 3.35%, it earns ₹33.5 crore by keeping money with RBI.
- If the rate increases, banks park more funds with RBI.
- If the rate decreases, banks lend more to customers, stimulating economic activity.
2. Bank Rate
Definition: The interest rate at which RBI lends to commercial banks for the long term, usually without repurchasing agreements.
Current Bank Rate: 6.75%
Impact:
- Used to penalize banks for not maintaining required reserves.
- Affects interest rates on government borrowings and loans.
Example:
If a bank borrows ₹100 crore at a bank rate of 6.75%, it repays ₹106.75 crore after a year.
- If RBI increases the bank rate, borrowing costs rise, discouraging credit expansion.
- If RBI lowers the bank rate, borrowing becomes cheaper, encouraging economic activity.
3. Marginal Standing Facility (MSF) Rate
Definition: The interest rate at which banks borrow overnight funds from RBI against approved government securities when they exhaust their regular borrowing limits.
Current MSF Rate: 6.75%
Why It Matters:
- Used for emergency funding by banks when they face a shortfall.
- Acts as a ceiling for interbank lending rates.
Example:
If a bank faces an unexpected liquidity crunch at night, it can borrow from RBI at 6.75% through MSF instead of seeking high-interest loans in the market.
- If MSF is high, banks avoid borrowing and reduce lending.
- If MSF is low, banks borrow more, increasing money supply in the economy.
4. Standing Deposit Facility (SDF) Rate
Definition: A facility where banks can deposit excess liquidity with RBI without needing collateral.
Current SDF Rate: 6.25% (Same as repo rate)
Purpose:
- Introduced in 2018 to manage excess liquidity in the banking system.
- Works as an alternative to reverse repo, but without securities.
Impact:
- If the SDF rate increases, banks prefer to keep money with RBI, reducing liquidity.
- If the SDF rate decreases, banks lend more, boosting economic growth.
Impact of a Repo Rate Cut on the Economy
1. Macroeconomic Impact (Nationwide Effects)
| Sector | Impact of Repo Rate Cut |
|---|---|
| Economic Growth | Boosts GDP as borrowing becomes cheaper. |
| Inflation | Can increase demand-driven inflation. |
| Stock Market | Encourages investments; markets often rally. |
| Rupee Exchange Rate | May weaken due to higher liquidity. |
2. Microeconomic Impact (Individuals & Businesses)
| Group | Impact |
|---|---|
| Home Loan Borrowers | Lower EMIs, making houses more affordable. |
| Businesses | Cheaper loans encourage expansion and hiring. |
| Fixed Deposit Holders | Lower interest rates reduce returns on savings. |
| Stock Investors | Lower rates increase stock valuations. |
Example:
- A person with a ₹50 lakh home loan at 8% interest pays an EMI of ₹41,822.
- If the interest rate drops to 7.5%, the EMI reduces to ₹39,974, saving ₹1,848 per month.
Liquidity Adjustment Facility (LAF) and Its Role
The Liquidity Adjustment Facility (LAF) is a key monetary policy tool used by the RBI to manage short-term liquidity fluctuations in the banking system. It consists of repo operations (to inject liquidity) and reverse repo operations (to absorb excess liquidity). The LAF operates within a corridor, where the Standing Deposit Facility (SDF) rate acts as the floor (lower bound) and the Marginal Standing Facility (MSF) rate serves as the ceiling (upper bound). This corridor helps stabilize overnight interest rates and ensures that liquidity remains within desired levels. For example, when there is excess liquidity, banks prefer depositing surplus funds at the SDF rate (currently 6.25%), while in times of shortage, they borrow from the MSF rate (currently 6.75%). By adjusting these rates, the RBI influences money supply, controls inflation, and maintains financial stability.
Conclusion
RBI’s repo rate cut to 6.25% is aimed at boosting economic growth while keeping inflation in check. However, the effectiveness depends on how banks pass on the benefits to borrowers and businesses.
For UPSC aspirants, understanding repo and related rates is crucial for topics like monetary policy, inflation control, economic growth, and financial inclusion. A well-balanced repo rate helps maintain stability, encouraging both savings and investments in the economy.
This topic is particularly relevant for Economy & Banking Awareness in UPSC Prelims and Mains (GS Paper 3). Keep track of future monetary policy updates, as they shape India’s economic landscape!
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