Inflation, Recession and Repo Rate

Breaking news today(12-Jun-2008) !!! RBI(Reserve Bank of India) has hiked repo rate by 0.25 basis point to 8%.

What does it mean ? Why does RBI need to hike the rate ?

Ok, first of all what is repo rate.

Repo Rate is a rate at which RBI lends money to the banks.

What is the significant of repo rate on economy? why does RBI hike the repo rate ?

To curb the inflation, RBI hikes the repo rate. If RBI hikes the repo rate than bank will have to pay more intrest to borrow money from RBI so what bank will do is they will pass this burden to the consumer and increase the intrest rate on loans(i.e. Personal Loan, Housing Loans, etc.). So, because of increase in intrest rate people will stop buying goods, house, etc. because of people not buying goods, price of the goods will fall because of lack of demand and which will inturn reduce the inflation !!! (Looks too optimistic, but think big, it works... :p )

Impact of hiking Repo Rate is profitibility of companies which are sesitive to intrest rate like Auto, Real Estate, Banking, etc. will go down because of hike in intrest rate and hence the stock market will fall (see the impact today, SENSEX is down about 350 pts.).

US is using same repo rate to curb recession, US is lowering repo rate. So, what will be the impact? Bank will have to pay less to borrow money from the Central Bank, bank will pass the same to the consumer by lowering intrest rate on loans. Because of low intrest rate people will start buying goods, house, and some will repay their mortgage at lower intrest rate(sub prime crisis). Hence, because of increase in demand price of goods will go up and profitibility of the companies will go up, to curb the demand comapny will start hiring more people so more job will be created, consumer confidence index will go up, comapnies will start giving good financial results, stock market will go up and hence economy can back on track.