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Reverse Repo Normalization

  • Posted By
    10Pointer
  • Categories
    Economy
  • Published
    2nd Feb, 2022

In a recent report, State Bank of India, which is the largest public sector bank in the country, has stated that the stage is set for a reverse repo normalisation.

Context

In a recent report, State Bank of India, which is the largest public sector bank in the country, has stated that the stage is set for a reverse repo normalisation.

What is monetary policy normalisation?

  • India’s central bank, the RBI, keeps changing the total amount of money in the economy to ensure smooth functioning by following two approaches.
    • Loose monetary policy
    • Tight monetary policy
  • Loose monetary policy
    • It is adopted when the RBI wants to boost the economic activity.
    • RBI injects more money (liquidity) into the economy: It does so by buying government bonds from the market. As the RBI buys these bonds, it pays back money to the bondholders, thus injecting more money into the economy.
    • RBI also lowers the interest rate: that it charges banks when it lends money to them; this rate is called the repo rate. Lower interest rates and more liquidity, together, are expected to boost both consumption and production in the economy.
  • Significance
    • Boosts consumption- For a consumer, it would now pay less to keep the money in the bank thus incentivising current consumption.
    • Boosts production- For firms and entrepreneurs, it would make more sense to borrow money because interest rates are lower.
  • Tight monetary policy- 
    • It involves the RBI raising interest rates and sucking liquidity out of the economy by selling bonds (and taking money out of the system).
    • When a central bank finds that a loose monetary policy has started becoming counterproductive (leading to a higher inflation rate), it normalises the policy by tightening the monetary policy stance.

What is Reverse Repo?

  • The reverse repo is the interest rate that the RBI pays to the commercial banks when they park their excess “liquidity” (money) with the RBI.
    • The reverse repo, thus, is the exact opposite of the repo rate.
  • Under normal circumstances, that is when the economy is growing at a healthy pace, the repo rate becomes the benchmark interest rate in the economy.
  • That’s because it is the lowest rate of interest at which funds can be borrowed.
  • As such, the repo rate forms the floor interest rate for all other interest rates in the economy — be it the rate you pay for a car loan or a home loan or the interest you earn on your fixed deposit etc.

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