03 August 2011
The repo rate is the difference between the purchase price and reselling price of a security, expressed as a percentage.
If commercial banks are short of money, they enter into an agreement with the Reserve Bank of India to sell their Treasury bills or gilt edged securities and then repurchase these securities at a slightly higher price.
For example, they may sell a treasury bill for Rs100 and then agree to buy it back at Rs105. The repo rate is effectively a 5% interest rate because that is the % difference between the two.
If the Reserve bank of India increases the repo rate it will increase general interest rates throughout the economy.
If the repo rate for commercial banks increases they will pass this onto their own consumers. Higher interest rates have the effect of reducing spending, investment and economic growth. This will reduce inflationary pressures in the economy.
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