Repo (Repurchase Options)

Repo (Repurchase Options)
(Concept , Impact Analysis on Economy & Trends)



Technical Definition :


Repo is a financial agreement used primarily in the government securities dealt in money market or capital market whereby a dealer or other holder of such government securities sells the securities and agrees to re-purchase them at an agreed future date at an agreed price which will provide the lender with an extremely low risk return.

Reverse Repo is simply the same repurchase agreement from the buyer’s viewpoint, not the sellers. Hence, the seller executing the transaction would describe it as a “repo”, while the buyer in same transaction would describe it as a “reverse repo”.

So, Repo and Reverse Repo are exactly the same kind of transaction, just described from opposite viewpoints.



Understanding the Concept in Indian Economy Context :


Repo Rate is the rate at which the banks borrows from RBI. Whenever the banks have any shortage of funds to meet their current demand and term liabilities, they can borrow from RBI.

Reverse Repo Rate is the rate at which RBI borrows money from banks.

Repo Rate is the thus, the difference between borrowed and paid back cash expressed as percentage.


Differentiation from Loan Concept :


Although, the actual effect of whole transaction is identical to a cash loan, while using the “repurchase” terminology, the emphasis is placed upon the current legal ownership of the collateral securities by the respective parties.



Forms & Types of Repo Agreements/ Auctions :


Forms of Repo :

• Specified Delivery : It requires the delivery of pre specified bond at the onset and at maturity of the contractual period.

• Tri-party : This utilizes a tri-party clearing agent or bank and is more efficient.

• Held in Custody : This form is quite rare in development markets primarily due to risks associated with its nature.

Types of Repo Maturities :

• Overnight Repo : refers to one day maturity transaction.
• Term Repo : refers to a repo with specified end date.
• Open Repo : simply has no end date.


Securities settled in Repo Transactions/Auctions :

All transferable Government of India dated securities and Treasury Bills.

Minimum amount of Repo Transactions/Auctions :

Bids will be received for a minimum amount of Rs.5 crore and in multiples of 5 crore thereafter.

Participants in Repo Transactions/Auctions :

• All Scheduled Commercial Banks (excluding RRBs).
• Primary Dealers maintaining SGL and Current A/c with RBI.


Impact Analysis on Indian Economy :

The changes in Repo Rates or Reverse Repo Rates are likely to have impact across the sectors and can be enumerated as follow:

• Financial Sector - Banking / Credit System / Markets – Debt or Equity
• General Economy
• Industrial Sector
• Corporate Sector
• External Sector
Impact on Financial Sector – Banking / Credit / Markets (Debt or Equity)


The Central Bank of India (RBI) manages short – term falls and surpluses in the banking system through its LAF(Liquidity Adjustment Facility), whereby it borrows and lends money at fixed rates under the repo and reverse repo facilities.

Since, RBI technically has unlimited capacity to lend and borrow rupees, the repo and reverse repo rate act as a ceiling and a floor rate for the interest rates.

When RBI cuts the repo rate, it is in effect sends the signal that short term rates are too high and should come down. The central bank has been traditionally using the repo to signal short term rates and the bank rate to indicate its view on long term rates.

However, with the longer –term interest rates being increasingly driven by short-term money markets, the repo signal has been used to nudge banks to bring down their Benchmark Lending Rates.


Regulation of Money Supply / Liquidity in Monetary - Credit System :

To temporarily expand the money supply, the RBI decreases repo rates which will help banks to get money at cheaper rates while to contract the money supply, it increases the repo rates which makes the borrowings expensive.

Repo is the injection of liquidity by the RBI while Reverse Repo is the absorption of liquidity by RBI.

Due to this fine tuning of RBI using tools of CRR, Bank Rate, Repo Rate and Reverse Repo Rate, banks adjust their lending or investment rates, hence, infusing or diffusing liquidity in the Monetary and Credit system.

Impact on Markets (Debt /Equity) :

Bond Markets will be the biggest beneficiary as the rate cut will make it easier for banks to borrow short term money and invest in government securities at a marginal spread.

The rupee will weaken in the foreign exchange markets as Indian debt will be become less attractive for foreign investors.

The impact on Stock Market will be mixed as Equities are largely driven by portfolio flows, which in turn are largely unaffected by the central bank’s monetary measures.

Other Impacts :

Reduction in Repo Rates may lead to cut in :

• Floating Home Loan Rates / Consumer Loan Rates.
• BPLR (Benchmark Prime Lending Rates).
• May usher in a lower rate regime if liquidity stays easy.

While, Rising Interest Rates would mean higher EMI payments, this would, in turn affect consumer durable companies as well as financing companies.


Impact on General Economy

The interest rate hike will bring a general slow down in the economic activity as higher cost of funds would result in reduced consumption and investment expenditures. As a result, the aggregate demand will also get a hit.

Impact on Industrial Sector

The interest rate hike will increase the cost of raw materials and thus, high cost of funds which will result in reduced industrial investment. This could adversely affect the Greenfield projects.

Impact on Corporate Sector

With increase in rates, due to higher raw material cost and fuel cost, corporate profits are likely to go down. Reduced bottom line of corporate sector implies lower plough back of profits.

Impact on External Sector

Higher Interest Rates leading to Higher Interest Costs will adversely affect the competitiveness of the Indian Exports.

Changes in Repo Rates or Reverse Repo Rates could reduce the differential between the Fed Fund Rates (USA) and EU Main Operation Refinancing rates. Expectedly this could lead to higher capital inflows into India, leading to strengthening of the Balance of Payments situation.







Trends in Reverse Repo Rates (Year 2000 - 2008) :

Following is the chronology of Repo Rates since June 2000. The central bank of India (RBI) holds daily repo and reverse repo acutions as part of its Liquidity Adjustment facility. (Exemplary table attached in Annexure I).
-------------------------------------------------------
RATE (percent) EFFECTIVE DATE (Source : RB I)
-------------------------------------------------------
7.50 03-11-2008
8.50 24-06-2008
8.00 11-06-2008
7.75 30-03-2007
7.50 31-01-2007
7.25 30-10-2006
7.00 25-07-2006
6.75 08-06-2006
6.50 24-01-2006
6.25 26-10-2005
6.00 31-03-2004
7.00 19-03-2003
7.10 07-03-2003
7.50 12-11-2002
8.00 28-03-2002
8.50 07-06-2001
8.75 30-04-2001
9.00 09-03-2001
10.00 06-11-2000
10.25 13-10-2000
13.50 06-09-2000
15.00 30-08-2000
16.00 09-08-2000
10.00 21-07-2000
9.00 13-07-2000
12.25 28-06-2000
12.60 27-06-2000
13.05 23-06-2000
13.00 22-06-2000
13.50 21-06-2000
14.00 20-06-2000
13.50 19-06-2000
10.85 14-06-2000
9.55 13-06-2000
9.25 12-06-2000
9.05 09-06-2000
9.00 07-06-2000
9.05 05-06-2000
Annexure – I

Policy Rates & Reserve Ratios
(As on 09/11/08)



Policy Rates


Bank Rate : 6%

Repo Rate : 7.50%

Reverse Repo Rate : 6%



Reserve Ratios



Cash Reserve Ratio : 5.50%

Statutory Liquidity Ratio : 24%



(Source : www.rbi.org.in)



















Annexure – II (RBI Circular on Repo Dated November 3rd, 2008)


RBI/2008-2009/257
FMD.MOAG. No.28/01.01.01/2008-09
November 3, 2008

All Scheduled Commercial Banks (excluding RRBs) and Primary Dealers


Dear Sir,

Liquidity Adjustment Facility – Repo and Reverse Repo Rates


1.As already announced on November 1, 2008, the Reserve Bank has decided to reduce the fixed repo rate under the Liquidity Adjustment Facility (LAF) by 50 basis points from 8.0 per cent to 7.5 per cent with effect from November 3, 2008, in view of the ebbing of upside inflation risks as also to address concerns relating to the moderation in the growth momentum.

2. The reverse repo rate under LAF remains unchanged at 6.00 per cent.

3. All other terms and conditions of the current LAF Scheme remain unchanged.