Repo is what banks pay to borrow from the RBI and Reverse repo is what they get when they park excess funds at the RBI.
Over the last two years we have only seen money parked with the RBI, meaning the system was flush with money and banks weren’t quite lending. From May this year, after the 3G and BWA auctions, banks have started to borrow from the RBI instead, an order of 60,000 crores every day. (Repo means they have to place high quality securities with the RBI which they buy back – or “repurchase” – the next day or in a short period.)
The differential of 0.25% costs the entire banking system a miniscule 35 lakhs a day (0.25% of an average 50,000 crores) which is a sort of rounding error, but it’s not what they do anymore, it’s what they intend to do.
Even though liquidity is tight, bank margins are wide,so there is a cushion. But the interesting question is: at what point does the credit system break the back of inflation? RBI says it expects 6% inflation by year end.
At a time when inflation’s gone through the roof, so to speak, we try to assuage ourselves saying that things will get better because, look at 2008. But oil prices were at $140 then, versus $80 today. Inflation fell because oil prices fell to $30, and alongside we did see corporate growth come down (but India’s growth didn’t fall too much, remember)
I don’t think it’s a supply issue that’s driving inflation. Supply problems would affect availability and literally everything, from fuel to CNG to tomatoes is available. If this is a demand problem – too much demand – then this piddly 0.25% is not going to help. In that case, I expect another policy rate increase as early as end August – bigger than 0.25%.
Inflation indexes will change. The WPI will have a different series with the base year as 2004-05, but we don’t know from when. Food’s weight should go down, so inflation must moderate just looking at things that way.
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