Yet again RBI has increased the CRR by another 50 basis points and Repo by 25 basis points. Now CRR and Repo rates stand at 6.5% and 7.75% respectively. This is the third time since Jan 2007 , RBI has done this in its continued battle against rising inflation.
This write up is an effort to simplify the concepts like CRR and Repo and explain their impact on inflation and liquidity.
CRR-Cash Reserve Ratio- It is the portion of cash balance that every bank has to keep with RBI and it is calculated every fortnight. It is simple! more the CRR, more the cash to be deposited with RBI and inturn it reduces the lendable cash balance of Banks and reduces the supply of money in market. Thus it is used as a weapon to reduce inflation.
Repo-Repurchase agreement- In simple language Repo is referred as Selling to buy and Reverse repo is the inverse of that. Here RBI sells the govt. securities, to Banks at certain rate and after the stipulated period it buys back them paying , a price which is over and above what it received. For example if the RBI sells the security at Rs.100 and buys back them after, say 1 year at Rs. 110, then Rs. 10 is the interest paid by RBI for the amount it received while selling the security. And this is called as Repo rate. When RBI increases the Repo rate Banks will park more money in govt. securities to earn more interest and this will again reduces their lendable balance and hence the liquidity in the market is reduced and inflation curbed.
