Understanding RBI action and its implication

Understanding RBI action and its implication

Lets us try and understand how the RBI rate manipulation affects us directly.

Money is basically known as currency and the word is derived from the word current (flow).  The nature of money is circulation, flowing from one hand to the other.  When we buy something, as a buyer your money outflows and at the other end as a seller the money flows in. This exchange of money happens billions of time in a day in a country.

Every time money changes hands value also gets exchanged. Meaning needs and wants are met, profits are made, salaries are paid, assets are created, taxes are collected, etc. This cycle keeps going on and on.

Money flowing furiously creates a good economy with large beneficiaries.  But there is a flip side to this. High money flow ends up increasing the prices of goods and services. This happens primarily because more money is chasing fewer goods.  This is what is known as inflation.

And how is this executed by RBI? 

Repo rate: Bank many a times borrows money from RBI to service its needs. RBI charges interest rate on them and that is called as Repo rate. Higher the repo rate higher will be bank benchmark interest rates. Which means when you place deposits with your bank the interest rate will be high and similarly if you borrow money from the bank the interest rate will be higher.

Cash Reserve Ratio: Simply put, banks are asked to keep a certain percentage of their client’s deposits with RBI. That portion of the money is locked and are not allowed to flow in the economy. Higher the cash reserve ratio, lesser money flow in the economy and lower the cash reserve ratio better the money flow in the economy.

How will these actions impact you?

Cut in repo rate will translate to lower interest rate on your bank deposits and lower interest rate on your loans.