Context:
The Reserve Bank of India (RBI) plans to conduct an eight-day variable rate reverse repo (VRRR) auction on Thursday aimed to drain â‚ą 1.5 trillion from the banking system.
What is Variable Rate Reverse Repo (VRRR)?
- A short-term liquidity absorption tool used by the RBI to take out excess liquidity from the banking system.
- Mechanism: Banks park their surplus funds with the RBI for a specified period (e.g., 7 or 14 days). The interest rate is determined through an auction (hence “variable rate”).
- Objective: To manage liquidity, control inflationary pressures, and align short-term rates with the policy repo rate.
Difference Between VRR and VRRR
| Feature | VRR (Variable Rate Repo) | VRRR (Variable Rate Reverse Repo) |
|---|---|---|
| Purpose | Inject liquidity into system | Absorb liquidity from system |
| Flow of Money | RBI → Banks | Banks → RBI |
| Collateral | Banks give G-secs to borrow funds | Banks deposit surplus cash |
| Impact | Eases shortage, reduces interest rates | Controls excess, supports inflation control |
Why is RBI Conducting this Auction?
- To drain â‚ą1.5 trillion excess liquidity from the banking system.
- Context:
- Banks currently have surplus liquidity due to government spending, deposit inflows, or RBI’s previous operations.
- Excess liquidity can lead to lower short-term interest rates, fueling inflation or creating asset bubbles.
- RBI conducts VRRR auctions to stabilize money market rates close to the repo rate.
Impact of VRRR Auction
On Banks
- Surplus liquidity gets parked with RBI → less cash for lending in short-term markets.
- Short-term money market rates (like call money rate, TREPS) may rise closer to policy repo rate.
On Economy
- Helps control inflationary pressures by reducing excess money supply.
- May tighten short-term liquidity, making borrowing slightly costlier for corporates and NBFCs.
On Investors
- Higher short-term rates → better yields on money market instruments (CPs, CDs, T-bills).
- Bond market may see some pressure if liquidity tightness continues.
