MUMBAI: The Reserve Bank of India (RBI) is set to conduct a seven-day Variable Rate Reverse Repo (VRRR) auction today (Friday) aiming to absorb Rs2 trillion from the banking system.
The VRRR auction comes in response to the persistent surplus liquidity in the system, which stood at Rs3.11 trillion on Wednesday, according to the latest RBI data.
Surplus liquidity in the banking system typically stems from a combination of factors such as government spending, inflows from foreign exchange operations, and changes in the cash reserve cycle. The RBI estimates this surplus by observing various indicators including the Weighted Average Call Rate (WACR), the Tri-party Repo (TREPS) rate, and banks’ parking behaviour in reverse repo auctions.
While surplus liquidity might suggest a well-funded system, it can undermine monetary policy transmission. With ample funds available, overnight money market rates like the WACR tend to fall below the repo rate, blunting the effectiveness of RBI’s policy signals.
For instance, the WACR currently stands at 5.35 per cent, lower than the repo rate of 5.50 per cent, while the TREPS rate has slipped even further, hovering at 5.28 per cenr, below the Standing Deposit Facility (SDF) floor of 5.25 per cent.
The VRRR auction serves as a liquidity management tool where banks are invited to park excess funds with the RBI at variable rates. This mechanism helps re-anchor short-term interest rates closer to the policy rate, maintaining order and predictability in the money markets.
On Friday, nearly Rs2.07 trillion worth of earlier VRRRs are also maturing, making the timing of this fresh Rs2 trillion auction critical for liquidity alignment.
TREPS, or Tri-party Repo, is a short-term borrowing tool where lending is done against government securities. A clearing agency manages the trade, mitigating counterparty risk.
TREPS
TREPS has become a key benchmark for overnight liquidity and is now being considered by RBI as a potential operative target, perhaps even replacing the WACR in the future.
If surplus liquidity isn’t mopped up, banks may begin chasing riskier avenues in search of yield, potentially jeopardising financial stability. It may also slow down the rate at which RBI policy changes – like interest rate cuts – reach businesses and consumers through lower borrowing costs.
Earlier in the week, banks had already parked Rs1.5 trillion through a seven-day VRRR, but refrained from locking more funds due to fortnight-end balance sheet considerations and uncertainty over future RBI actions.
Despite such hesitations, today’s auction is expected to be fully subscribed, helped by upcoming GST outflows of around Rs1.2 trillion, which will naturally reduce liquidity.
In summary, while a liquidity surplus sounds comfortable on paper, it can distort money markets and dilute monetary policy effectiveness. The RBI’s action through VRRR aims to preserve the sanctity of the interest rate corridor, ensuring the central bank retains control over short-term rates and broader financial conditions.
