The Indian economy is influenced by multiple factors, and one tool that the Reserve Bank of India (RBI) uses to manage it effectively is the monetary policy.  

As a part of this policy, RBI decides the repo rate to control inflation and manage the money supply in the country. Furthermore, banks and financial institutions also change their deposit and lending rates based on the repo rate also interest rates on loans.  

Repo Rate, also known as repurchase rate, is the rate at which RBI lends money to commercial banks in India to manage their liquidity needs. It uses this rate to control the supply of money in the country and influence the cost of borrowing in our economy 

Picture this. ABC Bank needs ₹5,000 crore by tomorrow to meet withdrawal demands. It can't wait for customer deposits to roll in. So, it pledges government bonds worth ₹5,000 crore to RBI, get the cash at the current repo rate, then repurchase those bonds 24 hours later. Done. 

A higher repo rate means banks pay more for these overnight loans. That cost gets passed to the end consumer through higher interest rates on home loans, car loans, everything. Lower repo rate means cheaper borrowing for banks, which usually translates to better rates for customers. 

How Repo Rate Works 

Commercial banks hold a lot of government securities as investments. When their cash dries up, they use these securities as collateral with the RBI to borrow money. 

Here's the flow: 

• Bank needs ₹10,000 crore urgently 
• Pledges government securities to RBI 
• RBI credits ₹10,000 crore at ongoing repo rate 
• Bank repurchases securities after 1-7 days 
• Interest charged based on repo rate 

Impact on Inflation and Liquidity 

When inflation exceeds comfortable levels, typically above RBI's target range, they increase the repo rate to restrict money supply. Banks borrow less, credit becomes costlier, consumer spending moderates, and inflationary pressures ease. 

Liquidity management works through this same channel. Excess liquidity can fuel inflation, while insufficient liquidity stifles growth. By adjusting the repo rate, RBI fine-tunes the amount of money circulating in the economy. A 25 basis point change might seem small, but its cumulative effect across the banking system amounts to billions of rupees entering or leaving circulation. 

Effect on Borrowing and Lending Rates 

Your loan rate is impacted by RBI’s monetary policy. However, they don’t change their rates the day RBI announces a repo rate hike. Banks take some time to adjust their lending rates. They're recalculating their borrowing costs, of which the repo rate is just one part. Lenders also consider other costs like: 

• Cost of savings deposits (which they pay to customers) 
• Fixed deposit rates (competing for funds) 
• Market competition (can't price out customers) 
• Profit targets (shareholders demand returns) 

Connection with Economic Growth 

Every economy needs capital to grow. Businesses borrow to buy machinery, hire workers, open new factories. Individuals take loans for homes, vehicles, education. This borrowing is economic activity. 

Cheap loans (low repo rate) accelerate growth. A startup borrows ₹2 crore at 9% to expand. Hires 50 people. Those 50 people spend salaries. Their spending becomes someone else's income. Multiplier effect kicks in. 

Expensive loans (high repo rate) slow everything down. That same startup faces 13% interest now. Too risky. Expansion postponed. 50 jobs not created. Multiplier effect works in reverse. 

Influence on Home Loans and EMIs 

For most Indians, a home loan represents the largest financial commitment of their lifetime. Since these loans typically run for 15-20 years, repo rate changes accumulate substantial impact over the loan tenure. Most home loans in India carry floating interest rates linked to external benchmarks, often the repo rate itself. 

Consider the following example. Suppose you take ₹50 lakh home loan at 8.5% p.a. for 20 years. The monthly EMIs amount to approximately ₹43,391. If the repo rate increases by 50 basis points and banks pass on the entire increase to the borrower, the interest rate rises to 9%.  

The new EMI jumps to ₹44,986, an additional ₹1,595 monthly or ₹19,140 annually. Over the remaining loan tenure, this translates to lakhs in extra interest payments. Borrowers can use the EMI calculator from Finnable to understand these impacts before committing to a loan. 

Effect on Savings and Fixed Deposits 

The repo rate influences deposit rates as well, though the relationship works differently. When RBI raises the repo rate, banks can borrow from the central bank at higher costs. This creates an incentive to attract more customer deposits instead. Banks raise fixed deposit rates to pull in funds, benefiting consumers with better returns. 

Conversely, when the repo rate falls, banks' cost of borrowing from RBI decreases. They no longer need to compete aggressively for deposits, so FD rates decline. Savers earn less on their deposits. This dual impact explains why repo rate decisions affect both borrowers and savers, albeit in opposite directions. Higher rates burden borrowers but reward savers, while lower rates benefit borrowers at the expense of deposit returns. 

Changes in Loan Eligibility and Feasibility 

Lenders assess loan applications based on repayment capacity. They typically ensure that EMI doesn't exceed 40-50% of monthly income. When interest rates rise due to repo rate hikes, EMIs for the same loan amount increase. This might push the EMI-to-income ratio beyond acceptable limits, reducing the loan amount a borrower qualifies for. Besides income, lenders also evaluate credit score as a key factor in determining eligibility. 

Someone who could afford a ₹30 lakh loan at 8% might only qualify for ₹25 lakhs at 9.5%. This affects home purchase decisions, forcing buyers to either increase their down payment, look for cheaper properties, or postpone their purchase. For existing borrowers, rising rates strain budgets and may require reducing EMI burden through loan restructuring or prepayment strategies.