What is repo rate?
The repo rate is the interest rate at which the Reserve Bank of India (RBI) loans money to commercial banks. Repo is an abbreviation for Repurchase Agreement or Repurchasing Option. Banks obtain loans from RBI by selling qualifying securities. Essentially it is the interest charged by the RBI when banks borrow from them – much like commercial banks charge us interest for a car loan or home loan, education loan etc.
Repo rate’s relation with the stock market & economy
The stock market and the interest rates have an inverse relationship. Every time the central bank increases the repo rate, its immediate impact is seen on the stock markets.
It means that following the hike in the repo rate prompts companies to cut back on the spending on the expansion, which leads to a dip in growth and affects the profit and future cash flows, resulting in a fall in stock prices.
Basically an increase in interest rates means an increase in savings and a reduction in the flow of capital to the economy, which results in slump in stock markets.
Further, the impact of the change in repo rate does not have the same effect on all sectors. For example, the capital-intensive sectors such as capital goods, infrastructure, etc, are more vulnerable to these changes due to high capital or debt on the books of these companies. While stocks of sectors like Information Technology (IT) or Fast-moving consumer goods (FMCG) usually see a lesser impact.
As the repo rate rises, it makes borrowing money from a bank a non lucrative affair. This, in turn, slows down the investment and money supply in the market because the purchasing power of people comes down.
It is generally very inevitable that if the purchasing power reduces, people would have lesser money to invest in stocks. Also, investors have to deal with the rising inflation rates. Thus, investments in stocks witness a downward trend.
This Repo rate increase will adversely affect people with existing loans. However, this decision has been made to curb the rising inflation. Restricting the cash flow in the market through this increase in repo rate is of utmost importance to arrest inflation. The credit demand has increased in the market due to the pandemic lockdown, the effects of the Russia-Ukraine war, and inflation. However, with the new hike in the repo rate, the credit supply will be limited. The RBI has raised rates by a total of 190 basis points since May 2022. Bringing inflation down is one of the main focuses of the RBI currently in order to sustain the value of the currency and serve economically weak societies.
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