What is reverse repo rate and why did the RBI cut it twice in 21 days?

• The Reserve Bank of India (RBI) today announced a second reverse repo rate cut in 21 days, bringing it down to 3.75%.
  
• Earlier, on March 27, RBI had announced the first rate cut by 90 basis points, bringing it down from 4.90% to 4%.
  
• The drastic reduction in reverse repo rates makes it less attractive for banks to deposit excess funds with RBI.
  
• This will infuse liquidity in the market, helping businesses running short on funds due to the Coronavirus lockdown.
  

In a bid to encourage banks to lend more money, the Reserve Bank of India today announced a reduction in the reverse repo rate by 25 basis points, bringing it down to 3.75%. This is the second time that RBI cut reverse repo rate in the last 21 days.

RBI cut reverse repo rate twice in the last 21 days as the Indian economy came to a virtual standstill due to the Coronavirus lockdown. The first cut was announced on March 27, reducing it by 90 basis points from 4.90% to 4%.

The second reverse repo rate cut announced today brings it down by 25 basis points, from 4% to 3.75%.

Here, we try to understand what exactly reverse repo rate is and why RBI cut it twice in the last three weeks.

What is reverse repo rate?

Reverse repo rate is the interest rate at which the RBI borrows money from banks for a short-term. This is an important monetary policy tool that is used by RBI to control the liquidity in the market.

If the reverse repo rates are high, banks tend to deposit their excess cash with the RBI. In return, they get interest and their deposits carry zero risk since they are secured against government securities.

How is reverse repo rate different from repo rate?

Reverse repo rate is the rate at which banks deposit money with the RBI. Banks deposit money with the RBI when they have excess or idle money, which happens when banks don’t lend money to borrowers.

On the other hand, repo rate is the rate at which banks borrow money from RBI. This happens when banks don’t have enough money to meet their short-term requirements.

Why did the RBI cut reverse repo rate twice in 21 days?

Due to the ongoing Coronavirus lockdown, the Indian economy has come to a virtual standstill. The International Monetary Fund (IMF) has slashed India’s GDP forecast to 1.9% for the year 2020-21.

As a result of the lockdown, there is an excessive liquidity crunch in the Indian economy. To help improve liquidity, RBI has reduced the reverse repo rate by a total of 115 basis points in the last 21 days, bringing it down from 4.90% to 3.75%.

With reverse repo rates falling drastically, banks are expected to lend more money to borrowers, instead of depositing them with the RBI. This will make sure businesses can borrow funds from banks and continue their regular operations instead of going bankrupt.

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