RBI’s dependence on VRRR may increase as liquidity likely to improve further over the next few months, say experts

Reserve Bank of India

An expected increase in banking system liquidity over the next few months on account of inflows related to Rs 2,000 notes, and government spending, could force the Reserve Bank of India (RBI) to announce more variable rate reverse repo (VRRR) auctions to mop up the excess liquidity, experts said.

The central bank could also use more open market operations (OMO) to manage the excess liquidity, they added. OMOs refer to the sale or purchase of government securities by the RBI.

The lower liquidity in the banking system will help call money rates align with the repo rate.

"The RBI will continue with VRRRs after the advance tax outflow as the RBI is not comfortable with a TREP rate lower than 6.25 percent. But participation in VRRRs will be liquidity and rate driven,” said Arun Bansal, Head of Treasury, IDBI Bank.

The tri-party repo (TREP) is a risk-free money market where banks lend and borrow.

The surplus liquidity in the banking system is likely to narrow after June 15 due to advance tax payment outflows worth around Rs 70,000 crore, Bansal added. Even after taking into account GST outflows of around Rs. 1.5 lakh crore, system liquidity will continue to be positive.

According to Gaura Sengupta, India economist at IDFC First Bank, the purpose of liquidity management is to keep overnight rates near the repo rate. This is being achieved by absorbing 66 percent of the liquidity via VRRRs, and the rest via the standing deposit facility (SDF).

“The dependence on VRRRs will increase as liquidity is likely to improve further over the next few months,” Sengupta said in a report.

On June 8, RBI Governor Shaktikanta Das said that the central bank is aiming to align the call money rates with the repo rate, which indicates that the RBI will remain in liquidity absorption mode.

Repo is the rate at which the central bank lends short-term funds to banks.

The liquidity surplus in the banking system is likely to come down in the second half of June due to advance tax outflows. At this juncture, there is expected to be surplus liquidity in the banking system to the tune of around Rs 2.01 lakh crore as on June 8, according to the RBI’s money market operation data.

Since May 25, the liquidity surplus has continued on its upward trend due to month-end government spending and inflows of Rs 2,000 notes into the banking system after it was withdrawn from circulation.

Das said that around 50 percent of the Rs 2,000 currency notes in circulation as of the end of March had returned to the banking system.

This constitutes around Rs 1.8 lakh crore of the Rs 3.62 lakh crore of Rs 2,000 notes in circulation as of March-end, said Das.

The RBI governor added that around 85 percent of the notes have come back to the system in the form of bank deposits, while the rest were exchanged for notes of other denominations.

According to the RBI’s money market operations data, Rs 49,635.45 crore of surplus liquidity in the banking system as on May 24 had surged to Rs 2.01 lakh crore on June 8.

To remove excess liquidity in the banking system, the central bank conducted five reverse repo auctions between June 1 and June 9.

However, the response from banks remained muted. Across all the auctions, banks parked Rs 1.57 lakh crore against the Rs 5.50 lakh crore that the RBI had offered to absorb.

Das has said that going forward, the RBI will remain nimble in its liquidity management while ensuring that adequate resources are available for the productive requirements of the economy.

The increase in surplus liquidity eased call money rates in the interbank money markets, which were above the repo rate and close to the marginal standing facility rate last month.

To address the issue of higher call money rates, the central bank last month conducted a 14-day variable rate reverse repo auction worth Rs 50,000 crore.

As Moneycontrol reported on May 19, this auction was aimed at addressing the stress of some banks as the surplus liquidity was not evenly distributed among the banks.

Further, on May 22, RBI Governor Das said our repo operations were to address the problems of such banks which did not have liquidity.

Between April 21 and May 15, call money rates were trending above the repo rate and close to the marginal standing facility rate, in the range of 6.35-6.80 percent, according to Bloomberg data. Once the liquidity started improving, call money rates fell below the repo rate of 6.5 percent.

Bansal added that the money market rate will be volatile and may hover between 6.25 and 6.75 percent,  depending on RBI operations.

“The call rate is likely to hover around the repo rate of 6.50 percent,” said Ritesh Bhusari, Joint General Manager of South Indian Bank.