The document discusses changes in repo and reverse repo rates in India over the past few years. It defines repo and reverse repo rates, and how the Reserve Bank of India uses them as tools to manage liquidity and influence interest rates. The document examines how repo and reverse repo rate changes impact inflation, credit availability, exchange rates, and interest rates. It provides data on movements in repo and reverse repo rates from 2008-2010 and the impact on inflation during that period. Measures taken by the IMF to standardize statistical treatment of reverse transactions are also summarized.

1. CHANGES IN REPO & REVERSE REPO RATE IN INDIA SINCE PAST FEW YEARS

2. What is repo rate? Repo rate, or repurchase rate, is the rate at which RBI lends to banks for short periods. This is done by RBI buying government bonds from banks with an agreement to sell them back at a fixed rate. The RBI wants to make it more expensive for banks to borrow money, it increases the repo rate. Similarly, if it wants to make it cheaper for banks to borrow money, it reduces the repo rate

3. What is reverse repo rate? Reverse repo rate is the rate of interest at which the RBI borrows funds from other banks in the short term. Like the repo, this is done by RBI selling government bonds to banks with the commitment to buy them back at a future date. The banks use the reverse repo facility to deposit their short-term excess funds with the RBI and earn interest on it. RBI can reduce liquidity in the banking system by increasing the rate at which it borrows from banks. Hiking the repo and reverse repo rate ends up reducing the liquidity and pushes up interest rates.

4. What Does Basis Point – BPS Mean? A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly used for calculating changes in interest rates, equity indexes and the yield of a fixed-income security. The relationship between percentage changes and basis points: 1% change = 100 basis points and 0.01% = 1 basis point. So, a bond whose yield increases from 5% to 5.5% is said to increase by 50 basis points; or interest rates that have risen 1% are said to have increased by 100 basis points.

5. Characteristics of repo rate Overnight repos are 1 day loans; Term repos have terms of greater than 1 day—usually weeks to months. The firm that makes the loan for a repo, usually a bank, has a reverse repo position which is simply the opposite side of a repo. An open repo is a contractual relationship that allows the borrower to borrow funds up to a certain limit, without signing a new contract—somewhat like an open credit arrangement.

6. Determinants of repo rate The repo rate for a particular transaction depends on the following factors: Credit quality: like most other securities, the interest rate varies inversely with the credit quality of the issuer—the higher the credit quality, the lower the repo rate. Liquidity: greater liquidity lowers trading costs and, therefore, the repo rate. Delivery: if the collateral must be physically delivered, the lender will charge a higher repo rate to cover its cost. Collateral availability: if the collateral is a special issue that is hard to get, the seller of the collateral will be able to obtain a lower repo rate from a lender that needs the collateral.

7. Advantages of repo Repos can provide a variety of advantages to the financial market in general & in debt markets in particular; significantly: Repo is a tool for funding transactions. For institutions and corporate entities, repos provide a source of relatively inexpensive finance. Central banks can use repo and reverse repo as an integral part of their open market operations with the objective of injecting/withdrawing liquidity into and from the market and also to reduce volatility in short term in particular in call money rates.

9. Credit channel

10. Interest rates

12. Impact on credit channel The credit channel describes the way in which monetary policy affects demand via banks and other financial institutions. If the interest rate rises, banks choose to decrease their lending and instead buy bonds. This means that households and companies find it more difficult to borrow money. Companies that are either unable or unwilling to borrow must cut back their activities, postpone investment and so on, and this dampens activity in the economy.

13. Impact on exchange rates The exchange rate channel describes how monetary policy affects the value of the currency. Normally, an increase in the repo rate leads to a strengthening of the currency. In the short term, this is because higher interest rates make Swedish assets more attractive than investments denominated in other currencies. The result is a capital inflow and increased demand for kronor, which strengthens the exchange rate. Monetary policy also plays an important part for the exchange rate in the long term.

14. Impact on inflation How changes in the repo rate affect inflation The way in which changes in the repo rate affect inflation and the rest of the economy is known as the transmission mechanism. The transmission mechanism is actually not one but several different mechanisms that interact. Some of these have a more or less direct impact on inflation while others take longer to have an effect. It is generally held that a change in the repo rate has its greatest impact on inflation.

16. MOVEMENTS OF REPO & REVERSE REPO SINCE APRIL’O8

17. REPO & REVERSE REPO IN 2009

18. GRAPH FOR 2009

19. Inflation in India for the year 2009

20. REPO & REVERSE REPO IN 2010

21. REPO & REVERSE REPO IN 2010

22. Inflation in India for the year 2010

23. Liquidity conditions In the last decade the year 2010, is proving to be the worst as far as liquidity in the banking system is concerned, the cash crunch is at its worst this time. The banks raising money to the tune of Rs. 1.59 lakhcrore, by using the repo route is in indicator of how bad the things are at the moment, as far as liquidity in the banking system is concerned. The government hasunveiled plans of injecting Rs 48,000 crore into the system. Liquidity is expected to remain tight for the rest for the financial year despite incipient signs pointing towards the contrary. The signs of easing of liquidity pressures on the market came from the reduced bank borrowings from the Reserve Bank of India's (RBI) repurchase or repo window. Bank borrowing from the repo window towards the calendar year-end was down to Rs 1.2 lakh crore. Bank borrowings from the repo window had hit an all-time record of Rs 1.72 lakh crore on December 22.

24. MEASURES TAKEN BY IMF Over the past eight years, the IMF Committee on Balance of Payments Statistics (Committee) has taken a considerable interest in the statistical treatment of reverse transactions. At its 2000 meeting, the Committee set up the Technical Group on Reverse Transactions (TGRT), with the following terms of reference: • To determine the recording practices (for transactions and positions) for repurchase agreements and securities lending by the principals, custodians, intermediaries, and fund managers, depending on the data sources and the information sought — position or transactions — and whether these transactions/positions can always be identified • To determine what are the recording practices for a reverse repurchase agreement/security borrowing (for the principal, the custodian, the intermediary, or the fund manager) when a repurchase agreement then is undertaken with the same instrument

25. Recent update The current repo rate is 6.25%. The current reverse repo rate is 5.25% At present, the RBI is planning to sell securities worth Rs.48000 crore in the coming few months.

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