Repo Rate is one of the important components of monetary policy of Reserve Bank of India. The central bank uses it to regulate the supply of money and the inflation rate in the economy.

For example, only just now (Wednesday) a 6-member monetary policy committee (MPC) at RBI has hiked the repo rate by 25 basis points, making it 6.5 percent in, possibly, the hope to contain inflation.

Now the low or high repo rate directly involves the central bank and other commercial banks. BUT it also indirectly affects the common people in the country.

For uninitiated, the repo rate is a rate at which RBI lends money to other commercial banks. It’s almost similar to when you take a loan from a bank. Say, if you take an education loan from your local bank, you have to pay them regular interests. Similarly, when these commercial banks need money, they approach the Reserve bank of India. RBI lends them the required money but charges them an interest (repo rate) on the Principal Amount.

Now comes the question of how a change in repo rate affects money supply and contain inflation. Theoretically, it’s much simpler.

When RBI increases the repo rate (like it has done right now), it makes borrowing expensive for the commercial banks. Since expensive now, these commercial banks don’t borrow as much money as they would do otherwise. To equalize this, they increase their own interest rate on loans, making it difficult for their customers to borrow money.

Now the end customers do not have enough money to invest and spend, which end up reducing the supply of money in the economy. When money supply in the economy gets reduced, the inflation level decreases too.

The same theory applies even when RBI decreases the repo rate. When it does that, the cost of borrowing becomes cheaper for the commercial banks. The end customers can now take more loans at a cheap price. Meaning, they can invest and spend more. This, in turn, will increase the money supply in the economy, which eventually increases the growth rate of the country.

Increase or decrease in the inflation rate has a very direct impact on the common people like you and me. So, basically, with low or high repo rate, Reserve Bank of India pulls the strings to change our lifestyle rather easily.

Hopefully, it’s clear now how low or high repo rate affects even the last of the person in the economy.