RBI Unleashes Hike in REPO to fight Inflation

RBI Increases the Repo rate by 25bps to 8% with immediate effect.

The RBI has whipped its weapon of REPO hoping to tame the monster of inflation.
Let us understand the Fundas behind the above mechanism of Repo fighting the inflation…..

Fundas First:

INFLATION: The general upward trend in prices across the economy is Inflation. In Funda terms it means Too Much Money chasing too few goods….So what happens the Value of the goods increases. ….Lets take the example of real Estate…If 100 people are bent upon buying a property at certain layout with 60 dwelling units/ plots…..what happens the prices of these units go up on account of heightened Demand. ..got it any questions..relate the same with a Movie hall with 450 seats and 750 people waiting outside the hall frantically looking for tickets …the prices of the movie tickets will be jacked up…but this is not inflation as the prices are not official and the said increase does not sustain over a period of time.

REPO : The repo is the rate at which the RBI lends to banks, injecting liquidity into the economy. An increase in policy rates would essentially mean that banks too would increase their lending rates and hence make the consumer think twice before availing a loan. This reduced credit offtake will thus bring down the money supply and control inflation — if the inflation is demand driven…i.,e too much money driving too few goods

But what we are witnessing today is an inflation driven more by scarcity of supplies than by a rise in demand. For example, limited land and water resources, low grain stock reserves and increasing diversion of food for bio-fuels, have all constrained availability of food and have taken global food prices to unprecedented highs in 2007-08. A rise in interest rates now will be punishing, as it might accelerate the pace of the slowdown thus affecting economic growth.

CRR & SLR :
CRR, or cash reserve ratio, refers to a portion of deposits (as cash) which banks have to keep/maintain with the RBI. This serves two purposes. It ensures that a portion of bank deposits is totally risk-free and secondly it enables that RBI control liquidity in the system, and thereby, inflation. CRR is currently at 8.25%.
Besides the CRR, Banks are required to invest a portion of their deposits in government securities as a part of their statutory liquidity ratio (SLR) requirements.
Mechanism: The government securities (also known as gilt-edged securities or gilts) are bonds issued by the Central government to meet its revenue requirements. Although the bonds are long-term in nature, they are liquid as they can be traded in the secondary market.


The hike in repo rather than the reverse repo rate is a signal to banks that they should be managing their own liquidity amicably without going overboard on lending.