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Repo Rates

by Anupam Manur & Varun Ramachandra

The Repo rate is the interest rate at which the Reserve Bank of India lends to commercial banks.

A cursory glance at the business section of newspapers shows us the concern or elation every time the Reserve Bank of India (RBI) hikes or reduces the Repo rate. Commonly called policy rates outside of India, a change in the repo rate can result in an upswing or downswing of markets.  The obvious questions in the minds of most readers are how does this impact our daily lives and is this the same interest rate that commercial banks levy on us? This article attempts to answer these questions and will hopefully leave the reader with a basic understanding of the significance of repo rates.

The Repo Rate:

The Repo rate (Repo is an acronym for repurchase) is the interest rate at which the RBI (Reserve Bank of India) lends to commercial banks.

The central bank of a country  is usually an independent institution that is set up with the specific intention of maintaining the stability of price and total outputin the economy ( this article will focus on the former). Price stability would result in consistent, and hopefully low, levels of inflation in an economy. Inflation, as Ludvig Von Mises describes it, is an increase in the quantity of money without a corresponding increase in the demand for cash holdings. High inflation leads to people having to spend more money to obtain the same amount of goods and services. The point to note here is that money, like all other commodities, is governed by the principles of demand and supply.

The RBI utilises several mechanisms to maintain price stability but its primary tool is the repo rate.  This  rate, which is charged by the RBI, is different from the interest rates charged by commercial banks.  In a commercial bank, if the interest levied is 8%, a loan of Rs. 50,000 would result in an interest sum of Rs. 4,000 after one year. So, the loaner, usually an individual or business, has to pay back Rs. 54,000 to the bank at the end of the year. The RBI however, does not lend to individuals or businesses, it instead lends to commercial banks in certain circumstances; central banks are usually referred to as the lenders of the last resort. The repo rate is the interest at which the RBI grants short term loans (15 days) to commercial banks facing shortage of funds.

Commercial banks borrow from the RBI on a regular (daily) basis, which explains the high influence of the repo rate. In the week of Mar 15 – Mar 20, 2015, commercial banks in India borrowed Rs.72,672 crores from the RBI at 7.75% rate of interest.

Repo Rate

Fig: Repo rates from March 2004

 Transmission Mechanism:

Hypothetically, if the RBI lowers the repo rate from 8.0% to 7.5%, commercial banks can borrow from the RBI at a cheaper rate. As the RBI has decreased the cost of borrowing for commercial banks, the demand for money will increase; as commercial banks can now borrow more money they can use these funds to lend more money to its customers. In essence, by cutting the repo rate the RBI increases the supply of money (the liquidity) in the market. Commercial banks will now have the maneuvering capability to decrease the lending and deposit rates charged to customers. A cut in the lending rate will induce more people to borrow while a cut in the deposit rate will induce people to save less and spend more. Both these mechanisms result in an increase of the disposable incomes of individuals, which further leads to increased consumer spending.  This sequence of events may not necessarily happen all the time, but a change in the repo rate generally gives the banks an impetus to act in the direction of the rates.

However, it must be kept in mind that a change in the repo rate by the RBI can also impact the exchange rate of the rupee. With all other factors remaining the same, a cut in the repo rate can lead to the depreciation of the rupee and vice versa. A fall in the repo rate can make most rupee denominated financial assets less attractive to investors than foreign currency denominated assets. The rate of return on most financial assets in a country will be tied to the interest rates (government bonds, equity, etc). Thus, when the repo rate decreases, the rate of return to the foreign investors also decline. This will precipitate a decrease in inflow of foreign currency into the economy, thereby reducing the demand for rupees which will cause the rupee to depreciate. The fallout of this is that imports become more expensive and the prices of exports go down.

A change in the repo rate can cause an increase or decrease in the supply of money in the markets, which has profound implications on the lives of people as this directly impacts the price of goods and services that we consume on a daily basis.

Anupam Manur is a Research Associate at Takshashila Institution  and can be found on twitter @anupammanur

Varun Ramachandra is a Policy Analyst at Takshashila Institution and can be found on twitter  @_quale



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Making Sense of India’s Latest GDP Figures

The new methodology to compute India’s GDP numbers is more comprehensive, accurate and in tune with international standards

The Ministry of Statistics came out with India’s GDP growth rate figures for the fiscal year 2013-14. Much to everyone’s surprise, the growth rate came out at 6.9 percent, much higher than the anticipated 4.7 percent. The 2.2 percent difference baffled everyone, including the RBI governor Raghuram Rajan, and the Chief Economic Advisor Arvind Subramaniam. The difference has raised a lot of questions and invited skepticism from both within and outside the government. Business newspapers have claimed that radical changes have been introduced in computing the GDP numbers, which explains the more positive numbers.

The Central Statistical Organization has introduced two big changes in computing GDP numbers: base year revision and using GDP at market prices. Before going into the technical aspects of these two changes, it should be mentioned that neither change is radical. The first of them is the change in base year from 2004-05 to 2011-12. The changing of the base year is a rather routine exercise carried out by the statistical offices around the world. In India, the base year has been changed numerous times and will henceforth be changed once every five years[1]. The other change is the adoption of a universal standard: that of using market prices instead of factor costs to make the GDP computations. This is mainly done to keep India’s numbers comparable with the rest of the world.


Base year analysis is mainly done to eliminate the effects of inflation and to give a more meaningful picture of the data. GDP measures the sum total of all economic activity within a country. This monetary value is first calculated in nominal terms or at current prices. It is then adjusted for inflation or the changes in the general price level over time and is thus, expressed in terms of the general price level of some reference year, called as the base year.  To make this slightly clear, assume that a country is producing only one commodity, say books. So, the GDP of that country would be the total quantity of books produced times the price of the book. Changes in the nominal value of the book over time can happen either due to a change in quantity or a change in prices. Change in real values captures only the change in the quantity of books produced.

Choosing the Base Year: Almost any year can be chosen as the base year, but ideally it should be a recent year to give a more meaningful idea. Since the index number of any series is set to 100 for the base year, it should also be relatively normal. Normal here means the absence of any large aberrations and upheavals in the economy (like extremely high inflation rate or an economy wide downturn).

The base year that was previously used in India was 2004-05. However, since then, there have been significant structural changes to the economy (as in any 10 year period) and a new base year had to be chosen to reflect these changes. The CSO has chosen 2011-12 as the new base year.


The bigger change that has been adopted by the CSO is the change from calculating GDP at factor cost to GDP at market prices. GDP at factor costs is a measure of national income that is based on the cost of factors of production. It is essentially looking from the producers’ side. It does not include the indirect taxes paid by the consumer but includes the subsidies given by the government. GDP at market prices essentially looks at economic activity from the consumers’ angle. It measures GDP at the last step of the transactions, which is the market price paid by the consumer.

It is clearly visible that GDP at market prices is always bound to be higher than GDP at factor cost. Removing subsidies and adding indirect taxes adds a significant part to the GDP numbers (as much as 7% in 2012-13). Thus, moving to GDP at market prices was always bound to give a different number.

Table showing the difference in GDP at factor cost and GDP at market prices (in Rupees trillions)


(Source: RBI Database on Indian Economy)

The Growth rates show a significant discrepancy as well. Look at the difference between the two approaches in 2008-09 and 2010-11.


(Both tables are based on the previous base year 2004-05).

The move to market prices can broadly be seen as a good move in terms of being comparable with world standards. IMF, World Bank and various international databases apart from the statistical organizations in different countries use the market prices measure. Market prices are usually a more comprehensive measure and give a better picture of economic activity. The CSO has also decided to include a range of previously not included sectors and activity. They have covered more sectors, more amount of financial intermediation, revision of labour activities, then also looked into the organized sector and the unorganized sector activity. It has also expanded its coverage of manufacturing and included under-represented sectors and data from the corporate database of the government in arriving at the growth figure. Overall, economists and statisticians would agree that the changes in the data measurement approaches are in a positive direction. A case in point is a statement by former CSO chief Pronob Sen “What has happened when we moved to the new base year is we’ve actually got better data. Basically if you look for instance in the corporate sector, we were earlier going with the RBI forecast and which were based on 2500 corporates. This time around we are using the MCA21data base which is five lakh companies as compared to 2500. So the quality of data has improved”.


However, the skepticism from different corners comes from the fact that the higher GDP growth numbers do not quite tie in well with numbers from other leading indicators of economic activity. For example, Index of Industrial Production numbers are down, so is the rate of gross fixed capital formation (investments). To bridge this gap and understand the discrepancy, we will have to wait a bit longer and wait for the revisions in the data of the other indicators, but for now, there does not seem to be much reason for complaints against this move by the CSO.


[1] The base years of the National Accounts Statistics series have been shifted from 1948-49 to 1960-61 in August 1967; from 1960-61 to 1970-71 in January 1978; from 1970-71 to 1980-81 in February 1988; and from 1980-81 to 1993-94 in February 1999. Thereafter it was changed to 2004-05 in 2006.

Anupam Manur is a Research Associate at The Takshashila Institution

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Snapshot of India’s Export Industries

This is written as a small addendum to Pavan’s insightful article on India-US trade. I shall aim to give a small snapshot of these commodities and their significance in the world trade.



The charts and tables above give a closer look at the top commodities traded with the US between 2009 and 2013 and their trends. The numbers above each bar represent the change in percentage terms over that period.

With a market share of about US$ 41 billion in 2013, the Gems and Jewelry industry in India is becoming one of India’s top foreign exchange earners. India imported US$ 3.9 billion worth of gem diamonds from the United States in 2013 and exported US$ 7.4 billion. Globally, India imported 163.11 million carats of rough diamonds worth US$ 16.34 billion and exported 36.46 million carats of polished diamonds valued at US$ 20.23 billion in 2013. The difference can be roughly seen as the value added by India. The country exported gems and jewelry worth about US$36 billion in 2013, significantly contributing to India’s foreign exchange earnings.

Exports of pharmaceutical products are also on the rise (132% over 5 years). Globally, the Indian pharmaceutical industry is ranked third largest in terms of volume and 10th largest in terms of value.  During 2013-14, pharmaceutical exports stood at Rs 90,000 crore (US$ 14.55 billion) globally.

The Indian chemical industry is also performing well. Basic chemicals and their related products (petrochemicals, fertilisers, paints, varnishes, glass, perfumes, toiletries, pharmaceuticals, etc.) form a very significant part of the Indian economy and account for about 3 per cent of India’s GDP. The Indian chemical industry is the second largest in the world. In 2012-13, India exported dyes and related products worth US$ 1.32 billion, organic chemicals worth US$ 619 million, and agro chemicals worth US$ 967 million.

Petroleum products mainly refer to India’s plastic industry. In 2012–13, exports of Indian plastics stood at over US$ 7.2 billion and have increased at about 20% each year.

The Indian textile and apparel industry is one of the largest in the world with an enormous raw material and manufacturing base. The present domestic textile industry is estimated at about US$ 33billion and unstitched garments comprise US$ 8.3 billion. The industry is a significant contributor to the economy, both in terms of its domestic share and exports; it accounts for a phenomenal 14 per cent of total industrial production, contributes nearly 30 per cent of the total exports and employs around 45 million people.

Coming over to imports, it is noteworthy that Indian imports of non-monetary gold have reduced since 2012. Non-monetary gold refers to an individual’s purchase of gold as against the gold held in the Reserve Bank’s vaults as a reserve asset. Gold imports peaked in 2012, which severely dented the current account balance and weakened the rupee. In late 2013, the RBI stepped in and took corrective measures like raising the import duties on gold. Generally, when inflation is very high (India’s CPI was about 9-10%), people rush to invest in alternative channels. When bank deposits gave you negative real returns, gold seemed like a good option for investment. The astronomical increase (115200%) in the imports of military aircrafts can be ignored as the data is zero for 2009 and about 1.2 billion in 2013.

Note: Industry specific data has been taken from http://www.ibef.org/exports



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Deflationary trend in the world economy

Falling prices and declining growth in China and Europe is adding further uncertainty in the fragile economic landscape.

China’s Consumer Price inflation figure rose to a measly 1.5 percent for December 2014, nearing a five year low. This was considerably lesser than the 3.5 percent rise expected by the government. Elsewhere, official inflation figure for the Eurozone was hovering in the negative at minus 0.2 percent, slipping the large economic area into a deflation. These, along with the falling oil prices, triggered a market collapse across the world.

Wait, falling prices are good right? Well, not quite and not for everyone. Signs of falling prices in India would indeed be greeted by great cheer, but that is because we have had an average CPI inflation rate of over 9 percent for three years running. However, falling prices in China or Europe is not necessarily a good sign.

For China, which has been showing sluggish growth in the past few quarters, reduced inflation rate means weak demand in the domestic economy. The phenomenon of a long-term decline in prices can cause consumers to sit on their money in the hope of lower prices to come, depressing the dynamism of consumption, investment and consequently, economic growth. Consumers are not willing to spend their money on goods and services, which will affect the sales and thus, profitability of the manufacturing sector. They will, in turn, reduce investment and job creation. This will ultimately lead to further reduction in growth. It is not as dire as this for China yet, but the low inflation number has sparked concerns in this direction.

Back in Europe, falling energy prices and a slight decline in Germany’s manufacturing sector has started a deflationary trend and correspondingly, a falling Euro. Deflation in Europe (along with massive debts) brings back nightmarish visions of Japan’s debt deflationary period in the 1990s and 2000s, which is often referred to as the ‘lost decades’.

Declining prices and a falling currency is bad news for the debtors. While prices and incomes might be falling, the debt does not. With the amount owed remaining the same, a household with falling income feels the burden of the debt much more. In the same vein, governments can fall prey to the same trap. If the prices and incomes are falling, so is the tax revenue, with which it was hoping to repay the debt.

Without resorting to stating the plain obvious, there is a lot of debt going around in Europe.

Add to that the fact that deflation brings along currency depreciation along with it. For countries with large international debt (debt denominated in foreign currency), such as Greece, the debt burden increases further. Greek’s foreign debt is 252 percent of its GDP (or a staggering € 400 billion). The government debt to GDP ratio is 166 percent. It is fair to say that Greece is in a soup and it will only worsen if the deflationary trend continues. Now, Greece has to pay a higher amount of Euros to convert them to, say, dollars to repay the debt.

What’s to be done? The People’s Bank of China has an easier solution than the European Central Bank. Current policy interest rate in China is hovering around 5 percent, which gives it ample flexibility to lower rates. Apart from that, the central bank is aiming to play a more proactive role in the economy by influencing lending rates by banks to businesses and by credit rationing into selective channels. It has also repeatedly made short term injections into the money market at the slightest hint of liquidity tightening.

The ECB on the other hand cannot possibly lower rates any more as real rates are already in the negative territory. The only viable medium term solution is to follow the footsteps of the Federal Reserve and have a go at Quantitative Easing (QE). QE refers to a process where the central bank of a country buys certain financial assets from the commercial banks in order to increase the monetary base and decrease the interest rates in the banking system. The Federal Reserve, after lowering the policy rate to zero percent, resorted to buying Treasury Notes and Mortgage Backed Securities from the commercial banks in the aftermath of the 2007 recession. With no significant impact on the economy, the Fed was forced to increase its monthly purchases of assets from $30 billion to $85 billion, until it had accumulated around $4.5 trillion in assets.

I shall reserve my thoughts regarding the effectiveness of QE as a policy instrument to another day. For now, good luck to the Greeks.

Anupam Manur is a Research Associate at the Takshashila Institution. 

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