The Reserve Bank of India (RBI) recently conducted a four-day variable rate reverse repo (VRRR) auction in response to the decline in overnight money market rates below the repo rate. This move aims to regulate liquidity in the banking system effectively. The repo rate, currently standing at 6.50%, serves as a benchmark for short-term borrowing by banks from the RBI.

During the auction, banks opted to park Rs 18,750 crore, falling short of the notified amount of Rs 250,000 crore. The weighted average rate settled at 6.49%, slightly below the repo rate. This followed a previous VRRR auction where banks contributed Rs 23,975 crore against a similar notified amount. The declining participation in these auctions underscores the changing dynamics of liquidity management by the central bank.

The downward trend in money market rates was evident, with the weighted average call rate hitting 6.13%, the lowest since September 15, 2023. Similarly, the treasury bills repurchase rate stood at 6.24% on Friday, down from 6.47% on Monday. This liquidity easing was partly attributed to government spending.

To address the evolving liquidity landscape, the RBI employs a nuanced approach. V RC Reddy, head of treasury at Karur Vysya Bank, explains the RBI’s strategy, stating that VRR auctions are conducted when interbank rates exceed 6.80%. Conversely, VRRR auctions are initiated when rates fall below the repo rate, ensuring alignment with the central bank’s policy stance.

Looking ahead, the RBI plans to conduct an overnight VRRR auction, aiming to withdraw ₹75,000 crore from the system. Market participants view these auctions as vital tools to address liquidity imbalances, particularly amid fluctuations in money market rates.

Beyond immediate liquidity management, the central bank’s actions seek to mitigate broader concerns regarding the distribution of liquidity. A dealer at a state-owned bank highlights this aspect, emphasizing the RBI’s efforts to address uneven liquidity distribution across the banking system.

The significance of liquidity management extends beyond short-term operations. With the Monetary Policy Committee (MPC) set to announce its decision, attention shifts to the committee’s stance on liquidity. Reddy anticipates the liquidity deficit to remain below ₹1.5 trillion for the week, underscoring the pivotal role of MPC remarks in shaping market sentiment.

The RBI’s implementation of variable rate reverse repo auctions reflects a proactive approach to managing liquidity dynamics. As market conditions evolve, these auctions serve as essential mechanisms to ensure stability and alignment with monetary policy objectives.