Growth And Inflation Due To Change In Repo Rate

To understand this let us know the following terms:

1.  Repo Rate : Repo rate is the rate at which the central bank of a country (RBI in case of India) lends money to commercial banks in the event of any shortfall of funds.

2. Reverse Repo Rate :  Reverse repo rate is the rate at which the central bank of a country (RBI in case of India) borrows money from commercial banks within the country.

If the repo rate is decreased by central bank (RBI in case of India) then at such condition more loan will be  taken by the banks. Due to much money with the banks and low interest rates people will be encouraged to borrow maximum loan from the banks.  So people have a lot of money in their hands which will ultimately results in following two things:

1.  Growth of the country

2. Inflation in the country

1.  Growth of the country:  Repo rate plays a vital role for the growth of the country.  As there is a lot of money with the public they would like to invest it in some productive and profit oriented activities like building industries of various kinds, houses, vehicles, infrastructures, etc. This results in the growth of the country and increase in the living standard of the public.

2. Inflation in the country: The rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling is known as inflation.  Repo rate plays a vital role for creating inflation in country. As there is a lot of money with the public, people can buy a lots of things they want in their life which means people have high purchasing power.  This high purchasing power of the public affects the country in many different ways and creates a lot of problems in the developing countries like India.  For example , if all people in the country buys a lot of vehicles, started constructing houses , buildings , etc . by their high purchasing power then it would be very difficult for the country to manage resources for this developmental tasks because the country has limited amount of resources like petrol , diesel, oil, minerals, steels, etc which ultimately increases  the price of these resources.  Let us take another example,  if people have the high purchasing power and they have the same need ( or let’s  say they all want same thing to buy in the market) then there would be huge demand of such thing in the market. Because of such huge demand and high purchasing power of the public the price of such thing increases drastically which results in the inflation in the country.

Conclusion: If RBI decreases its repo rate then it helps in the growth of the country which is a very good thing but it also increases the inflation which is a very bad thing for the country like India, so RBI must set its repo rate so as to maintain growth and reduce inflation in the country.