What are Repo and Reverse Repo?

Repo is the interest rate charged by the central bank (RBI) when commercial banks borrow money from it. It is a short-term loan where both the parties agree on the sale and future transactions within a specified contractual tenure.

''Repo'' stands for Repurchase Agreement or Repurchasing Option. Banks avail loans from the central bank by selling eligible securities. An agreement between the central bank and the commercial bank will be made to repurchase the securities at a price that is predetermined. This is done when banks face a shortage of funds or need to maintain liquidity in volatile market conditions. The RBI uses the repo rate to control inflation rates.

Reverse repo is the interest rate that the RBI pays commercial banks when they park their excess cash with the central bank. It is an act of buying securities to resell them in future for a profit.

By reducing the repo rates, the RBI can encourage economic activity in the economy. Repo and reverse repo are termed as ‘benchmark’ interest rates in the economy. Repos and reverse repos signify the same transaction but are titled differently, and as RBI is also a bank, it has to make more than it pays making the repo rate higher than the reverse repo rate.

On the basis of an assessment of the current and evolving macroeconomic situation, the Monetary Policy Committee (MPC) at its meeting on February 8, 2023 has decided to increase the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points to 6.50 per cent, while the reverse repo rate is 3.35 per cent.