RBI may opt for overnight VRRR to regulate liquidity

Bankers and analysts have indicated that the Reserve Bank of India (RBI) may need to resort to conducting variable rate reverse repo (VRRR) auctions to absorb liquidity for just a day. This comes as banks show reluctance to park funds for longer durations. A Prasanna, head of research at ICICI Securities Primary Dealership, explained that the RBI aims to maintain the overnight rate around the repo rate consistently, and conducting overnight VRRR auctions would be the simplest and most effective way to achieve this alignment.

Despite surplus liquidity exceeding 2 trillion rupees ($24.24 billion), banks have been cautious even as the central bank offered to withdraw money through 14-day, 4-day, 3-day, and 2-day VRRR auctions over the past week. The 2-day VRRR auction on Wednesday received offers worth only 18.50 billion rupees, significantly below the targeted 750 billion rupees. In the last four days, the RBI has absorbed 1.52 trillion rupees, falling short of the 4.50 trillion rupee target.

A treasury head of a state-run bank noted that upcoming tax outflows, including advance tax and GST tax, could influence the durable liquidity surplus in the coming weeks. As a result, the RBI may opt for overnight reverse repos until there is more clarity on the liquidity situation. Additionally, some traders have suggested that the RBI might consider a dollar-rupee sell/buy swap, injecting spot dollars while removing rupee liquidity. This action could impact the spot market, forward market, and overall liquidity conditions.

However, market participants have dismissed the possibility of measures such as increasing the cash reserve ratio (CRR), conducting open market sales of bonds, or issuing shorter duration bills under the market stabilisation scheme (MSS). Instead, the focus appears to be on short-term liquidity management through VRRR auctions and potential interventions in the foreign exchange market to address the liquidity challenges faced by the RBI.