A cut in Repo Rate changes the complete range of interests that are set by the commercial banks. These changes in interest rates affects the prices of bonds, shares and also affects the exchange rates. So, in turn a rise in the Repo Rate can help to check inflation. Repo Rate Cut might lead to higher levels of inflation.
We can explain this concept in the context of India.Repo Rate is the rate at which the commercial banks borrow funds from the Reserve Bank of India. At present, India is maintaining a Repo Rate of 7.75%. When Reserve Bank of India was going to declare its’ last monetary policy recommendations, the industry expected that a cut in Repo Rate would be introduced.
But, this was not done and Reserve Bank of India stated that, it had not taken the step of Repo Rate reduction in order to control the rising levels of inflation of Indian economy.There were expectations that Reserve Bank of India would cut the Repo Rate, in order cope up with the interest rate cut by Fed. As the US Federal Reserve reduced the interest rates thrice in the short period of September 2007 to January 2008, capital inflow in India started to rise.
This rising capital inflow increased the money supply in India, which triggered up the inflation.
Reserve Bank of India left the Repo rate unchanged in its’ last monetary policy review. It was done as; the Reserve Bank of India had the objective of keeping the inflation close to 5 percent. The fact is that, the credit growth in India has decreased in 2008 compared to the figure of January 2007. On the contrary, deposit growth has increased to 23.8% from the level of 21.5%. At present, the level of credit growth is below the level of deposit growth.
A cut in Repo Rate may change the complete range of interest rates that are determined by commercial banks. Interest rate of savings accounts, interest rate of mortgage loans, interest rate of overdraft may change with the cut in Repo Rate. These changes in interest rates affect the prices of bonds and shares and also affect the exchange rates. All these changes ultimately determine the level of inflation. So, it may happen that a Repo Rate cut results in to higher level of inflation.
Last Updated on : 30th July 2013