"Repo Rate is" Series; How Does It Affect Inflation?

In this article, I am going to write what Repo Rate is and how it affect inflation due to its change.

What is Repo Rate?

It is the rate at which the central bank gives credit to the commercial banks in form of securities. Increase in repo rate increases the interest rate and demand for credit reduction.

When the central bank increases repo rate, commercial banks also have to increase interest rate. This will slow down the money flow. When the central bank decreases repo rate, commercial bank also can reduce the rate. This will increase money flow in the financial market.

How Does Repo Rate Affect Inflation?

Repo rate is a great tool to control money flow to the economy. Businesses take money from Banks, stock market and bond market. If loan is very cheap, aggressive loan distribution may take place. It will increase NPL. You can read my article what NPL is by clicking this link. What is Non-Performing Loan - Meaning, Examples, Calculation . When NPL rises the cost of borrowing or the interest rate for upcoming loans rise. This increase the cost of production. This increased price of commodity thus increasing our expenditure of our daily lives. This means increase in inflation. The central bank increase the repo rate so that the bank don't go to aggressive loaning. This reduces NPL and ultimately keep interest at a stable point. This keep inflation at a stable point. But this doesn't mean that high repo rate is always good for us. High repo rate will increase interest rate. If it is too high it will force the bank to increase their interest rate. It will ultimately increase the cost of product. The possibility of high NPL is always there. This is the situation when high repo rate can trigger high inflation rate. Under this circumstance high inflation is inevitable.