Reserve Bank of India: RBI may soon step in to absorb excess liquidity

Mumbai: The Reserve Bank of India, after changing its policy stance to neutral and cancelling the daily and 14-day main variable rate repo (VRR) auctions, is expected to launch variable rate reverse repo (VRRR) operations in the coming weeks to absorb excess liquidity from commercial banks, according to economists.

This would help the RBI reinforce its neutral stance by ensuring that short-term money market rates like the tri-party repo (TREPS) and overnight call money rates remain within the liquidity adjustment facility (LAF) corridor, they said.

VRRR is a tool used by the RBI to manage surplus liquidity in the system, wherein banks bid to park surplus money with the central bank for a specific period. VRR, on the other hand, is used to inject liquidity into the banking system.

After the monetary policy review earlier this month, the RBI discontinued its daily VRR auctions and cancelled the 14-day VRR operation, signalling that it no longer sees the need to inject liquidity on a regular basis. However, with surplus liquidity still present in the system, short-term rates have started drifting below the standing deposit facility (SDF) rate of 5.25%, which is the lower end of the LAF corridor.

In the last week of May, the TREPS rate averaged 5.66%, about 9 basis points below the SDF rate, causing some confusion among market participants. Traditionally, under a neutral stance, the RBI is expected to prefer short-term rates to stay within the LAF corridor, which spans from 5.25% (SDF) to 5.75% (marginal standing facility), with the policy repo rate at 5.50% in the centre.

Economists believe that restarting VRRR operations-likely in the seven- to 14-day range-would help anchor the operative rate between the MSF and the SDF, maintaining the integrity of the corridor. “We expect the RBI to announce some VRRR operations to ensure that the short-term rates do not fall below the SDF rate, so as to maintain the sanctity of the LAF corridor,” Kaushik Das, chief economist-India, Malaysia and South Asia at Deutsche Bank, said in a report after the latest policy.While RBI governor Sanjay Malhotra stated that no decision has been made to align the operative rate with the repo rate, he acknowledged that resuming VRRRs could achieve that alignment. Market experts suggest that such operations may be used as a temporary tool to emphasise the neutral stance, especially until the RBI is satisfied with rate transmission and the rate cut cycle nears its end.