Repo rate is a discount rate at which the central bank repurchases government securities from commercial bank, depending on the level of money supply it decides to maintain in the country’s monetary system.
To temporarily expand the money supply, the central bank can decrease the repo rate (so that banks can swap their holding of government securities for cash). To contract the money supply, it increases the repo rates.
Alternatively, the central bank decides on a desired level of money supply and lets the market determine the appropriate repo rate.
Repo is short for repossession. Repo rate can be taken in simple terms as the rate at which banks borrow short-term funds from the BoN. It is secured nature of borrowing similar to a loan against fixed deposit available to individuals during emergencies.
Banks are mandated to invest a certain percentage of inflows into government securities (treasury bills, bonds etc). Only the excess over the mandated investment in government securities can be used to borrow funds from repo window. Generally, this kind of borrowing is used as the last resort as banks core borrowing has to come from more traditional sources such as deposit and corporate structured finance. However, liquidity (money availability) in the financial system might dry up given the paltry deposit rates that the banks are offering to clients.
Repo rate is used extensively by the Reserve Bank to maintain a tight liquidity flow. If repo rate is increased the overall cost of funds will also increase and if it decreases then the cost of funds will also decreases. Therefore, as of now, the repo rate remained unchanged and overall cost of funds will remain unchanged.
The way the repo rate affect the whole economy and particularly inflation is known in finance as transmission mechanism. The transmission mechanism is actually not one but several different mechanisms that interact. Some of these have a more or less direct impact on inflation while others take longer to have effect. Generally, change in repo rate has an impact on inflation in say a year or two. When repo rate changes, the so called overnight rate is affected.
The Reserve Bank will try by all means to make its monetary policy predicated and tries to effect expectations of future monetary policy by regularly publishing forecasts. Monetary policies have effect on interest rates the general public faces and on the total demand and supply in the economy.
The channels that market interest rates affect supply and demand can be divided into interest rate channel, the credit channel and the exchange rate channel. Monetary policy affects demand via banks and other financial institution. If interest rate rises, banks choose to decrease their lending and instead buy bonds. This means that households and companies find it more difficult to borrow money.
Companies that are either unable or unwilling to borrow must cut back their activities, postpone investments and so on and this dampens activity in the economy.
So a lower repo rate favours the flourishing of the economy though it may fuel inflation. The repo rate affects general interest throughout the banking sector and in turn affects the demand of goods and service. Higher interest rates normally lead to a reduction in household consumption. This happens for several reasons. High interest rates makes it more attractive to save, in other words to postpone consumption, thus lowering present consumption.
Consumption also falls because existing loans now cost more in terms of interest payments. Finally, higher interest rates mean that the price of financial and real assets - shares, bonds, properties, etc - falls in that present value of future returns drops when interest rates rise.
When faced with dwindling wealth, households become less willing to consume. A rise in interest rate also makes it more expensive for firms to finance investment. As a result, higher interest rates normally curtail investment. If consumption and investment falls, so does the aggregate demand.
Lower aggregate demand results in lower resource utilisation. When resource utilisation is low, prices and wages usually rise at more modest rate. However, it takes time before a decline in resource utilisation leads to inflation. As for Namibia, most of the effect to the currency comes from the South. We are pegged one to one to the rand so it might be very difficult to notice anything. Normally, an increase in the repo rate leads to a strengthening of the N$. In short term, this is because higher interest rate makes Namibian assets more attractive than investments denominated in other currency.
The result is a capital inflow and increased demand for N$ which strengthens the exchange rate. Currently, the opposite is true. Monetary policy also plays an important part for the exchange rate in the long term. Tighter monetary policy means a lower inflation, which in the long run can be expected to be reflected in a stronger exchange rate.
At the moment, the BoN expects inflation to push northwards on the back of our currency depreciation. However, the fact that inflation expectations are firmly anchored at inflation target is no reason for the repo rate to remain unchanged.
Given the central bank’s stance to keep rates unchanged, we forecast inflationary pressure from currency depreciation but might see borrowing unchanged mainly because banks will still continue to tighten loans’ access requirement.
With the lack of in-depth financial instruments, financial institutions will be happy with the current status quo.