What is repo rate?

The repo rate, set by the Reserve Bank of India (RBI), is the interest rate at which the central bank lends money to nationalized and private banks when they face a shortage of funds. This rate is subject to change depending on market conditions and has a significant impact on a consumer's purchasing power, particularly in the context of home loans. Let's explore how changes in the repo rate affect a homebuyer's home loan installment.

What is the meaning of repo?

Repo stands for ‘repurchase option’ or ‘repurchase agreement’. It is a form of short term borrowing that allows banks or financial institutions to borrow money from other banks or financial institutions against government securities with an agreement to buy those securities back after a specified time period and at a predetermined price (which is higher than the initial sell price).A repurchase agreement is a secured way of raising short-term capital for banks. The duration of these loans generally varies between one day to a fortnight. In this system, the borrower enters into a repo or repurchase agreement, whereas, for the lender, it’s a reverse repurchase agreement or reverse repo.In India, the Reserve Bank of India or RBI (which is the central bank in the country) lends money to commercial banks with an interest rate which is called repo rate. These loans are sanctioned in exchange for securities to help the banks achieve their financial goals. On the other hand, RBI also has provisions for banks to park their excessive funds for which RBI pays interest, which is determined by reverse repo rate. This interest rate is also applicable when RBI borrows money from commercial banks. RBI uses repo and reverse repo to maintain economic stability in the country. When there is a need for an economic boost, RBI pumps funds into the system by helping commercial banks borrow money from the bank. Using repo, banks raise the necessary capital to increase their lending capacity. This ensures liquidity for the bank and proper cash flow into the market. But, in the case of inflation, RBI uses reverse repo to absorb funds from the market to regulate the lending capabilities of commercial banks.

Governments around the world are responsible for regulating the money supply in their countries. In India, the RBI not only controls the issuance of currency notes but also determines the lending rate, which is the interest rate at which money is provided to borrowers. However, the RBI does not directly lend money to the general public; instead, it acts as a financial intermediary for commercial banks in the country. The rate at which the RBI lends money to these banks is known as the repo rate.

In situations where commercial banks face a shortage of funds, they can borrow money from the RBI to ensure the smooth flow of funds to their customers. The RBI lends money to commercial banks at the repo rate. Currently, the repo rate in India stands at 6.50 percent, but it can fluctuate in response to market conditions, significantly influencing consumers' purchasing power.

When the repo rate is high, commercial banks tend to reduce their borrowings from the RBI. This results in a decrease in the overall money supply in the economy, which, in turn, affects the purchasing capacity of consumers. Conversely, when the repo rate decreases, commercial banks increase their borrowings, ensuring better circulation of money in the economy and an increased spending capacity for consumers.

How does the repo rate impact the real estate market? Changes in the repo rate have a ripple effect across all sectors of the economy, including real estate. Given that property purchases require substantial investments, high lending rates can discourage buyers, as they lead to an increase in the overall cost of the property.

In response to the mounting inflationary pressures on the economy, the repo rate saw six consecutive increases totaling 250 basis points during the 2022-23 financial year. The first hike occurred in May 2022, after about two years of stability. Subsequent revisions took place in June, August, September, December 2022, and February 8, 2023. These measures were implemented by the government to control rising prices and ensure a healthy flow of funds. However, in the last four Monetary Policy Committee (MPC) meetings of the current financial year (2023-24) held on April 6, June 8, August 10, and October 6, the RBI refrained from further increasing the repo rate, maintaining it at 6.50 percent.

In contrast to a high repo rate, lower borrowing costs have a positive impact on consumers' purchasing power. An increased money supply implies that more loans will be approved, putting more money in the hands of buyers. This, in turn, strengthens their buying decisions, contributes to a healthier purchasing cycle in the economy, and encourages consumers to invest any extra funds they have. The RBI's current decision is seen as a move toward improved cash flow in the economy, ultimately boosting consumers' buying capacity and incentivizing investments.

Differences Between Repo Rate and Reverse Repo Rate

The key differences between Repo Rate and Reverse Repo Rate are based on the lender’s and borrower’s perspectives. It also differs on the impact the change in rates creates. They are:

• Repo Rate and Reverse Repo Rate are contradictory. Banks borrow money from RBI at Repo Rate, and on the other hand, they lend money to RBI at Reverse Repo Rate
• RBI uses Repo Rate as a mechanism to control inflation and Reverse Repo Rate to manage money flow
• Repo Rate injects liquidity in the market whereas Reverse Repo Rate absorbs liquidity from the market
• Usually, Reverse Repo Rate is lower than Repo Rate

Similarities

The policy rates may differ over who is the lender and the borrower between banks and RBI. However, they have the same governing body and similar objectives. The similarities between the two are:

• Monetary Policy Committee (MPC) headed by RBI Governor decides both Repo Rate and Reverse Repo Rate
• Both are a component of the Liquidity Adjustment Facility (LAF) which is a monetary policy that allows banks to borrow via repurchase agreements
• Both are RBI tools to check the bank credit floating in the market. When there is a rate change, the volume of market money rises or declines. The concentration or dilution of the funds affects investments as well as their diversity in the financial markets
• Both Repo Rate and Reverse Repo Rate aim at price stability which improves the efficiency of the financial system. This ensures economic development in the country
• Both are short-term mechanisms of RBI to control liquidity and inflation. The tenure for both is 7 days or 14 days, since the money has to be paid back after the term ends

Disclaimer: The views expressed above are for informational purposes only based on industry reports and related news stories. Estates61 does not guarantee the accuracy, completeness, or reliability of the information and shall not be held responsible for any action taken based on the published information.

RBI keeps the repo rate unchanged; home loan rates may remain steady

The Reserve Bank of India (RBI) has maintained the repo rate at 6.50 percent for the fourth consecutive time during the latest Monetary Policy Committee (MPC) meeting on October 6, 2023. This decision marks a departure from the expected 25 basis points (bps) increase in the repo rate amidst a global economic slowdown and rising inflation. The RBI's decision to keep the repo rate steady at 6.50 percent has been well-received by both homebuyers and developers.

In the previous fiscal year, the cost of raw materials increased, leading to higher housing unit prices. Rising repo rates also made home loan rates more expensive, discouraging potential homebuyers. However, the RBI's decision to maintain the status quo is expected to provide relief to buyers and stabilize lending rates until further announcements are made. This move may encourage homebuyers who had postponed their plans to start searching for favorable deals, helping the real estate sector despite inflationary pressures.

Experts also suggest that state governments should complement the RBI's decision by offering suitable rebates, such as reducing stamp duty and registration charges, to further boost homebuying activity across all segments.

MCLR, which stands for Marginal Cost of fund based Lending Rate, is the minimum interest rate that banks charge on loans. It was introduced by the RBI in 2016 to ensure consistency and fair pricing for customers. Changes in MCLR affect the Equated Monthly Instalments (EMI) of various loans, including home loans. An increase in MCLR makes these loans more expensive, and when the RBI announces a repo rate hike, banks usually follow suit by raising their lending rates.

The External Benchmark Lending Rate (EBLR) is the minimum interest rate set by banks for lending loans, and it is based on external benchmarks like the repo rate. EBLR is primarily used for floating interest rate loans.

The Repo Linked Lending Rate (RLLR) is a lending rate that is directly tied to the repo rate set by the RBI. Any changes in the repo rate directly influence the RLLR, causing the floating interest rate on loans linked to RLLR to fluctuate in response to repo rate revisions.

While the RBI periodically announces repo rate revisions, often leading to rate increases, the current decision indicates a degree of economic stability. To ensure that future revisions do not hinder the growth of the real estate sector, it is hoped that favorable home loan policies will be introduced, allowing homebuyers to continue their investments without disrupting the real estate landscape.

Disclaimer: The views expressed above are for informational purposes only based on industry reports and related news stories. 99acres does not guarantee the accuracy, completeness, or reliability of the information and shall not be held responsible for any action taken based on the published information.