Even though the fluctuations in the repo rate affect the total behaviour of businesses and consumers, its implications are more visible in the stock market.
Less than a week after Finance Minister Arun Jaitley presented the union budget in the parliament, Reserve Bank of India governor Raghuram Rajan surprisingly cut repo rate by 25 basis points to 7.5% from 7.75% on Wednesday.
Rajan explained the move was due to the recent fall in consumer inflation, recorded at 5.1 percent in January.
“It has been decided to reduce the policy repo rate under the liquidity adjustment facility by 25 basis points from 7.75% to 7.5% with immediate effect,” said the statement.
In the budget speech finance minister Arun Jaitley had announced the signing of a monetary policy framework. He had also said that the government would amend the RBI act to set up a monetary policy committee which will henceforth decide on policy rate.
What is Repo Rate?
Repo rate is the rate at which the RBI lends money to commercial banks due to shortfall of funds. It helps the Central Bank control inflation. During inflation, the RBI increases repo rate to lower the cash flow, thereby, making it more expensive to obtain money. Repo rate and stock prices are inversely related to each other. Industries like automobiles and real estate get affected seriously as these they gain the most when the repo rate falls. Companies which have high debts are affected the most.
Fluctuation in Repo rate since 2005
Since 2005, the repo rate has seen various fluctuations. The rate was at its high in July 2008, i.e 9% while it was only 4.75% in April 2008, the lowest so far since 2005. (The Average of each year has been shown in the above graphical representation)
Fluctuation in Sensex due to changes in Repo Rate (Since 2010)
As repo rate and Sensex have an inverse relationship, when the repo rate increases the Sensex reacts negatively. For instance, in March, 2011, the repo rate was hiked by 25 basis points leading to a nearly 200 points fall in Sensex. However, there have been exceptions for this as in 2011 and 2012 when the repo rate was hiked to 8 and 8.5% respectively but the market reacted positively. This was due to the presence of strong economic growth at that time.
However on Wednesday, Sensex jumped over 400 points when the RBI lowered repo rate by 25 basis points.