In a recent report, State Bank of India, which is the largest public sector bank in the country, has stated: “…we believe the stage is set for a reverse repo normalisation.”
The reverse repo is the interest rate that the RBI pays to the commercial banks when they park their excess “liquidity” (money) with the RBI. The reverse repo, thus, is the exact opposite of the repo rate.
Under normal circumstances, that is when the economy is growing at a healthy pace, the repo rate becomes the benchmark interest rate in the economy.
But imagine a scenario where the RBI pumps more and more liquidity into the market but there are no takers of fresh loans.
In such a scenario, Banks are more interested in parking their excess liquidity with the RBI. And that is how the reverse repo becomes the actual benchmark interest rate in the economy.
What does reverse repo normalisation mean?
Simply put, it means the reverse repo rates will go up.
Over the past few months, in the face of rising inflation, several central banks across the world have either increased interest rates or signaled that they would do so soon.
In India, too, it is expected that the RBI will raise the repo rate. But before that, it is expected that the RBI will raise the reverse repo rate and reduce the gap between the two rates.