1273596,Parul Bajaj ,F2, Q5- increase in Repo Rate? pros &cons in current scenario?

INTRODUCTION:

Reserve Bank of India Governor Raghuram Rajan raised the key repo rate on Tuesday, choosing once again to confound expectations while renewing focus on inflation as also the threat stemming from the weakening of the rupee amid a selloff that has rippled through emerging markets. The Indian currency recovered sharply after the policy announcement.

The repo rate, at which banks borrow short-term money from RBI, was raised by 25 basis points, or 0.25 percentage point, to 8 per cent.

"RBI (has) rolled up its sleeves again and raised the policy rate further to bring inflation under control," Eskesen said. This is the third time that Rajan has raised rates after taking over as governor in September last year — an increase of 75 basis points in four months.

The Reserve Bank's hiking the key lending rate by 0.25 per cent is a reflection of its "strong commitment" to check inflation, Prime Minister's Economic Advisory Council (PMEAC) Chairman C Rangarajan said today.

Brace yourself for a higher EMI burden: IMPACT

Pros & cons :

Repo rate is the rate at which RBI lends money to all the banks. So if RBI hikes its repo rate, it becomes costly for banks to borrow money from RBI so they in turn hike the rates at which customers borrow money from them to compensate for the hike in repo rate.

On Friday RBI increased repo rate by 25bps or 0.25% to 8.25%. Banks offer loans like home loans and auto loans to someone at an interest rate which is directly proportional to Repo rate. Now with the increase of 0.25% in repo rate, this increase will directly be passed to a common man.

Interest rate for common man will be repo rate plus the rate of interest on which he took the loan from the bank. So, if repo rate increases the interest rate of the loan will also increase. Thus increasing the EMI.

For example: If you had bought a house worth 30 lacs @10% interest, 15 yrs tenure, then the EMI would be Rs. 32,238. With an increase of 0.25% in interest, your EMI will rise to Rs. 32698.53.

So, that is how increase in repo rate impacts your finances.

When repo rates are increased, commercial banks have to return more money to RBI thus banks lend less money from RBI as a result of which the money available with banks is less to lend out in the market. Consequently, banks increase their loan interest rate as they have less money to hand out in the market which decreases amount of money in the market. Now, when people have less money with them they spend less which decreases demand of products and as a result prices go down.

 CONCLUSION :

Your home loans could get costlier and your budget squeezed further as the Reserve Bank of India (RBI) on Tuesday raised a key interest rate to tame high inflation.

Policy repo rates for banks act as a instrument for controlling the short term liquidity. Repo rates are defined as "The rate at which the RBI lends money to commercial banks is called repo rate. It is an instrument of monetary policy. Whenever banks have any shortage of funds they can borrow from the RBI."

When RBI increases the Repo Rates The cost of short term funds for the banks increase and hence in order to stay profitable they would be do the short term lending to the corporate and individuals at a higher rate than before.

This makes the corporates and individuals to restrain excess spending and hence a decrease in the demand. This cumulative decrease in demand leads to change in the prices of goods as now supply is at the same level but the demand has decrease in the short term. Hence a real decrease in prices leads to a  reduction in inflation.