MUMBAI: In a significant reset to its liquidity management framework, the Reserve Bank of India (RBI) will conduct variable reverse repo (VRR) auctions on all working days until further notice amid tight liquidity.
Liquidity in the banking system stood at a deficit of Rs 2.09 trillion lakh crore as of January 14, data from the Reserve Bank of India showed. VRR auctions enable the RBI to inject liquidity into the system.
According to banking industry experts, the daily VRR auctions will bring back the overnight repo rate back into play once again and give confidence to markets during the current uncertain times. Earlier, the multiple-day VRR and VRRR auctions were targeted at the weighted average call rate (WACR).
The VRRs, which will commence from Thursday for Rs 50,000 crore, will be held between Monday and Friday. The auction amounts will be decided by the regulator, based on assessment of the liquidity conditions, and will be announced on the RBI website. The RBI has conducted six VRR auctions so far this month to help cash-strapped lenders.
The RBI’s change in liquidity framework comes at a time, when there is significant uncertainty about the liquidity demand in the coming weeks. While there will be pressure on liquidity from next week onwards owing to outflows due to the goods and services tax, there is heightened fear about US President elect-Donald Trump taking charge from next week. The latter’s decisions, including inflationary policies to boost growth, could prompt foreign institutional investors to seek flight to safety.
Consequently, the rupee which has already fallen over 3% since September, could feel more pressure, forcing the RBI to defend it aggressively and putting further pressure on the liquidity. India’s forex reserves have already depleted to a 10-month low in January 3.
According to the latest notification, the RBI will decide the auction amount based on assessing the liquidity conditions and standalone primary dealers will be allowed to participate in these auctions, along with all other eligible participants, RBI said.
As per the revised liquidity framework introduced on February 6, 2020, the 14-day variable-rate repo/reverse repo auction is the primary liquidity operation, while overnight and up to 13-day auctions are classified as fine-tuning operations.
Madan Sabnavis, chief economist at Bank of Baroda, said “when the RBI introduced the new liquidity framework, by definition, the intervention was supposed through VRR and VRRR targeting the WACR. Therefore, the overnight repo rate became redundant in this framework. However, based on the current liquidity tightness, the RBI appears to have restored the overnight repo window to infuse liquidity on a daily basis and give confidence to market.”
He added that normally, the liquidity tightness improves from the first week of January, but this has not happened and part of the reason could also be because the RBI has been selling dollar (to defend rupee) as a result of which banks’ liquidity has come down. “This is an additional temporary tool being used by the RBI. It is one of the ways of improving sentiments in the market. For permanent measures, we need open market operations, buybacks or a CRR cut,” added Sabnavis.
Only one of the six VRR auctions conducted so far this month was overnight, with the rest for tenors of 3, 4, 5, and 14 days. The central bank conducted two 4-day VRR auctions in the first fortnight of January 2025.
Anticipating liquidity stress in the banking system, the RBI reduced the cash reserve ratio (CRR) of all banks to 4% of their deposits in two equal tranches of 25 bps each with effect from the fortnight beginning December 14, 2024 and December 28, 2024. This released primary liquidity of about ₹1.16 lakh crore to the banking system.
“This may be one of the suggestions to the RBI from heads of treasury. Demand is usually better for shorter tenure VRRs, therefore, daily VRRs will definitely have more participation and the demand will be better. Certainly, it will be more effective as they (RBI) are giving you the guarantee of conducting VRRs on daily basis, eliminating uncertainty in the market. Consequently, it will bring down the volatility in the overnight money market rates,” said Gaura Sengupta, chief economist at IDFC First Bank.
On Wednesday, the five-day variable rate repo (VRR) auction saw muted response, with banks borrowing just Rs 3,980 crore against the notified amount of Rs 75,000 crore.
Money market traders said that since there are no major outflows scheduled for the week, borrowing demand is tepid. Consequently, overnight rates have also come down from an average of 6.95% to 6.30-6.35%. Additionally, due to liquidity crunch, banks are borrowing more from the tri-party repo (TREPS) market than from the interbank call money market.
Today’s tepid reaction is in stark contrast with the VRR auctions on Friday, when banks put in bids of Rs 2.77 lakh crore for the first auction of Rs 2.25 lakh crore. This prompted the RBI to conduct a second VRR auction worth Rs 50,000 crore. This follow-up auction, too, received a robust response, with banks placing bids of around Rs 75,000 crore.
Source: The Financial Express