How will an increased "repo rate" control inflation?

RBI Governor, Shaktikanta Das Wednesday announced a hike in the key lending rate (repo) by 50 basis points taking the repo rate to 4.9%.

But how does an increase in the repo rate control the high inflation in the country?

We know the prices are determined by the factor of supply and demand of goods and services in our economy. Price rise in the country is usually caused by either deficit in supply or increase in demand or both.

In case of inflation in the country or shortage of funds, the commercial banks borrow money from the Central Bank i.e., the Reserve Bank of India, which is repaid according to the repo rate applicable.

Repo rates are increased by the Central Bank when prices need to be controlled, and they are decreased when there is a need for the generation of more money into the market to support the economy.


The reduced money supply helps control inflation because when less money is circulated against the same quantum of goods and services, the prices cool down.

Also because of increased repo rates, commercial banks pay more interest for the money lent to them and the change in repo rates affects public borrowings such as loan rates, and EMIs and makes costs of commodities like homes and vehicles costlier.

During this time, investors buy government bonds and interest-rate products because of higher returns. And more people invest in safe and long-term investments such as fixed deposits. It reduces money in circulation. Many banks in India have already raised FD rates across tenure. Moreover, the government may soon hike small savings schemes rates such as PPF, NSC, etc.

The Repo rates will also impact the other segments such as the consumer durables, the housing, and the banking sector.

Cyclical stocks of banking, automobile and manufacturers, hotels, etc will also be affected due to increased repo rates.

These factors will control the inflation in the country and demand and the value of the rupee will also increase.

Thus, various financial and investment instruments in the country are indirectly dependent on the repo rate.

As projected in the MPC the inflation is likely to remain above the upper tolerance level of 6% through the first three quarters of 2022-23. Inflation is now projected at 6.7% in 2022-23, Das said.