Repo Rate: Definition, Impact on bond market, stock market and economy

 

Repo Rate: Definition, Impact on bond market, stock market and economy

Repo Rate Definition

Usually overnight, the interest rate the Reserve Bank of India (RBI) lends money to commercial banks from government assets under collateral is known as the repo rate, or repurchase rate. To control inflation, liquidity, and economic growth the RBI mostly relies on it as a tool for monetary policy.

Dynamics of bond markets and interest rates

The effect of RBI's repo rate reduction is on bond market and economic interest rates. Governments, companies, and investors all have to realize this link.

Effect on bond yields and prices is

• A decline in the repo rate reduces market interest rates, therefore affecting bond yields.
• Bonds are more appealing at higher interest rates, which drives secondary market pricing.
• Cutbacks in the repo rate lower bond yields and increase bond prices.

G-Sec and T-Bills' Reaction

• A reduction in the repo rate reduces G-Sec and T-Bill rates, which lessens their appeal relative to stocks.
• As bond buyers buy equities, stock market liquidity increases.
• Reduced G-Sec yields lower government borrowing rates, hence improving budgetary control.

Corporate Bond Market Advances

• Reduced interest rates help to lower the cost of corporate bond issuing.
• Reduced rate refinancing of loans helps businesses with heavy debt.
• Investors looking for safety and better rates hunt AAA-rated corporate bonds.

Rates for fixed-deposit and savings accounts Fall

• Following repo rate declines, banks decreased FD and savings account rates.
• For those seeking alternatives, stock markets, mutual funds, and gold take front stage.
• Since deposit returns are lower, seniors and risk-averse investors look for higher-yield securities.

Impact on Personal and Home Loan Rates

• Repo rate reduction reduce the Marginal Cost of Funds-Based Lending Rate (MCLR), hence cutting borrowing costs.
• Interest rates on home, personal, and commercial loans have dropped, hence driving demand.
• Those that borrow long term—that of house loans—profit most.

Rupee and forex devaluation

• At lowered interest rates, Indian debt instruments appeal less to foreign institutional investors.
• Capital withdrawals could cause the currency to weaken.
• While an undervalued rupee increases import costs, it benefits exporters—especially those in the IT and pharmaceutical sectors.

Effects on Inflation

• Reduced interest rates help to boost the money supply, hence raising consumer demand.
• Should demand increases too much, inflation could increase, hence RBI would have to boost rates.
• Bond investors follow inflation constantly since it reduces bond returns.

Margin of Net Interest and Bank Profitability

• Reduced lending rates help banks increase loan growth.
• Lower deposit rates reduce NIMs, which, should they drop slower than lending rates, could compromise profitability.
• Lower borrowing rates help public sector banks and NBFCs most of all.

Performance of Debt Mutual Funds

• Debt mutual funds—especially long-term ones—do well when bond yields drop.
• Investors in long-term bonds and gilts win.
• Rate reductions lower liquid and ultra-short-term fund returns.