Engineer's Finance

Repo rate is the rate at which banks borrow funds from the RBI to meet the gap between the demand they are facing for money (loans) and how much they have on hand to lend.

If the RBI wants to make it more expensive for the banks to borrow money, it increases the repo rate; similarly, if it wants to make it cheaper for banks to borrow money, it reduces the repo rate.

How this affects us: If the bank is paying a higher rate of interest to borrow money, we are the one who will bear the cost — we will pay a higher rate of interest when we borrow money from them. This is how banks ensure that they continue to make a profit.

For example, let’s say you need money for some reason and you apply for a loan. The bank may have already exhausted all its available money by lending to other borrowers and does not have enough money to lend to you. This does not mean it will refuse your loan request.

The bank will go to the RBI and ask for money. The RBI lends this money to the bank at a fixed rate of interest (the repo rate fixed during the credit policy; the credit policy is announced every quarter). This tool helps the RBI increase the amount of money flowing into an economy (that is, it brings more money, as and when needed, into the banking system).

As of now, the Repo Rate is 8.5%.

Bank Rate – This is the rate at which the RBI (India’s Central Bank) lends the money to other banks such as ICICI, SBI, Canara bank and so on. It also lends money to the financial institution such as LIC housing finance and others.

The Bank Rate signals the future of RBI’s interest rates in a long term. If the Bank Rate moves up then the interest also tends to move up and vice versa.

The banks and financial institutions borrow money from the RBI at a lower interest and make profit by lending it at a higher interest rate. Generally the banks borrow money from either RBI or the other banks who have surplus deposits. If the RBI hikes the bank rate, the interest that a bank pays for borrowing money increases. It, in turn, hikes its own lending rates to ensure it continues to make a profit.

How this affects us: If the RBI keeps the bank rate unchanged, we may not really be affected. But if it increases the bank rate, be prepared to pay more for any loan that we have taken from a financial institution.

The bank rate will gives us an idea of the RBI’s long term view of the economy. If the bank rate goes up, it means things are going to get more expensive in the long run.

Bank Rate is at 6% as of now. It has not changed from 2007 AFAIK.

I was thinking about Inflation and thought can we really stop this? I don’t know how far my thoughts are valid but still here are those.

Inflation as covered in my previous articles would give you a rough idea about what is. According to me, people have got enough money to buy products but there are less products present in the market and due to scarcity they are sold in premium. Just because people have more money and willing to pay for that product more, those products are sold at a higher price only because of the demand and nothing else.

How can we stop this? Just think about this scenario. In a village there are 50 people and only 1 shop which sells rice. The shopkeeper buys the rice from a local trader. Trader buys the rice from farmers of a different village for Re. 0.90 per kg and sells to shopkeeper for Re.0.95. Trader can stock at most 2000 kgs of rice in his storeroom on a day. He gets rice from villages only once in two weeks. The shopkeeper can at most stock 150 kgs of rice in his shop.

Each person in Village was buying 1 kg of rice for Rs. 1.10 per day for his consumption, so for every day the rice shop used to sell 50 kgs of rice. Shopkeeper used to get his share from the trader once in 3 days. One day, Shop keeper provides the opportunity for people to buy 10 kgs of rice for Rs.10. Suddenly many were interested in such a deal and wanted to buy 10 kgs of rice, all of a sudden the demand increased but the supply could not be met. Shopkeeper asked for more and more rice and trader gives 500 kgs of rice in 4 days and all the stock is depleted in just 4 days. This was happening as a routine and the shopkeeper decided to increase the price of rice from 1 to 1.25. People thought since there is a huge demand for rice the price is increased and started paying the price for it and started stocking the rice thinking that the price may increase further. Instead of buying 10 kgs people started buying 20 kgs in order to stock it so that they have enough for the next 20 days. Slowly people started stocking more and more and the price started increasing gradually. One fine day it touched Rs. 2. Since shopkeeper was asking for more rice, trader saw this opportunity to increase his price, the farmers also hiked their price since there was a huge demand. AS and when the demand increased the price also shot up.

If we think about this scenario, what can we conclude? Who is at mistake? Most of them would say shopkeeper. I would say its the villagers. If they had not started buying the rice at bulk the prices would have not increased so much. Since they themselves created this situation, they are paying the price of it. If all the villagers had decided to buy just 1 kg of rice daily then there would have been no major difference between supply and demand. It would have been as usual for them.

I think this is how the prices fluctuate and Highly paid professionals are partly responsible for this. Since we are the guys who are ready to pay dearly and stock things and create the price hike for others also to pay. We get paid handsomely and hence it does not pinch our pockets but for a common man it does. I would suggest you to not to pile up things. I am not sure even about its consumption. (People waste most of the food.) This would bring down the prices I guess.

Yesterday I was asked a question by Satish (my colleague) regarding inflation in a different manner. Here it is:

What if the prices increases to Rs.1200 according to your example in the next ten months?

I told him I had not thought about this scenario and today I did a research on this and thought let me post my findings for his benefit and others who might have thought about it and did not share with me. The electronic gadgets prices fall and don’t generally raise over a period of six months. Since the technology changes every six months to one year and the prices will decrease since there will no demand for old technology products. One of my friend bought a Television for Rs. 18,500 in Jun 2007 and the same Television costs now Rs. 15,400. I bought a Television for Rs. 22k in March 2003 and the same costs just Rs. 9k now. I have not come across a scenario when the prices of old technology electronic gadgets sold at a premium.

And one other colleague said “It might be necessary for now to buy, later you may not require it or it will be of little use to you, so it is better if we buy it at the right time than save up and buy later”

I don’t buy this argument. If something is required to you now and not needed later then such a thing is just a waste to you and you are buying a product that you don’t actually need it. Electronic gadgets life is just 6 months to 1 year. I feel that the computers we buy are God for the first year and then some how it becomes Dog after that. The rate at which the technology is changing I feel that it is better to save up and buy since you might get a good deal on it and a better technology product. Moreover I don’t believe in just buying stuff just cause we want it. It should serve some purpose. Just for the fact that we can buy anything, we should not buy. It does not make sense to me now ( Got some gyan 🙂 ).

I know what I have done, I have bought gadgets that I have not used more than two months. So just think over it.

I will write more about Inflation in some time.

I hope many know what is meant by Inflation. There are always talks going on about Inflation in newspaper these days. It is right now 7% and this is the highest in the past three years.

This is the definition of inflation from wikipedia.

Whatever I understood :
The value of money decreases, i.e. Say today I can buy 10Kgs of rice with Rs. 100 and if inflation increases tomorrow I can only buy 9Kgs of rice with Rs. 100. This is very high level. With the same amount of money we will be able to get less than the previous situation. The prices of commodities increases and that is a concern, we can’t do much about it and government should take care of it.

We don’t really care about Inflation, do we? We wont bother about price raise as it is not pinching our pocket as we are all paid well but for a poor common man it is very bad thing. Inflation should be controlled.