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Tuesday, October 01, 2013

Understanding Repo Rate and MSF Rates

Understanding these two rates (Repo rates and MSF rates) lets you make an informed decision on when to enter or exit specific stocks and / or mutual funds. Even if not that, it helps you understand the general market movement whenever RBI (Reserve Bank of India) decides to alter these rates.

We have already studied about Repo Rate in one of our earlier posts - What is Repo, Reverse Repo and CRR. But since MSF Rate is a new concept and is related to Repo Rates, it was important to refresh our memories.

Repo Rate (Reverse Purchase Option), in nutshell, is the rate at which the banks borrow money from RBI (and they must sell their govt bonds to do that). Any increase in Repo rate by RBI means that banks need to shell out more interest to borrow more money. This in effect leads to liquidity crunch and slows down the economy. This is often a measure used to reign in inflation as well.

Many economy lovers and enterprise houses, including the general market sentiments feel that an increase in Repo rate is anti-economy. But there is another vital factor that must be understood before we derive any conclusions about the impact of increase or decrease in repo rates. This factor is called as MSF (Marginal Standing Facility) Rate.

Understanding MSF
At present, banks can borrow a limited sum of around Rs. 40,000 Crores from RBI at the running Repo Rate. Any amount above this level has to be borrowed at the running MSF rate. Since the banking systems borrowing requirements are much higher than this cap of Rs. 40,000 Crores, the MSF becomes the effective borrowing rate for a large portion of the banks. MSF rate is usually 1-2% higher than the Repo rate.

Impact of MSF Rate change
So, if the MSF rate has come down, while the Repo rate has gone up, it is very likely in a growing and stable economy like India that it is pro-economy rather than anti-economy. It is only in under developed economies where the banks borrow at Repo rates that there is a direct impact of repo rate hike on the economy and growth.

So, while the market may have reacted with emotions and reacted negatively on repo rate hike, understanding of the wider picture may just give you a golden opportunity to invest more funds in the stock market at the right time.



Cheers


Manoj Arora
Lead a Financially Free Life !!

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