Repo Rates & Reverse Repo Rates

In a situation like what we face in the Indian economy Today, with Food Inflation at its all time peak, RBI is toying with the idea of containing physical money supply from the system.

One of the Tools which RBI uses is the Repo and the Reverse repo Rates manipulation and it operates this way:

Repo is a facility extended by RBI to the Banks to borrow short term against its gilt securities. Any increase in the Repo rates dampens the enthusiasm of Banks to borrow against such securities and any decrease in it influences Banks to borrow.

Repo rates are characterised by sale followed by purchase of securities. When securities are sold to RBI, more money is released and the opposite effect takes place when Reverse Repo rates are applied by RBI when it sells its securities to Banks and follows it up with purchase on maturity.

Repo and Reverse Repo thus help the RBI control money supply.If it wants to squeeze it, RBI will increase both the repo and the reverse repo rates, and does the opposite if it wants to increase the money supply in the economy.