The Reserve Bank of India’s early moves to at least normalise the cost of liquidity, if not begin withdrawing it, are falling short. This, as the near Rs 11-lakh-crore liquidity surplus is keeping the cost of liquidity at close to the reverse repo rate, which acts as the floor on interest rates.
While the RBI and its governor Shaktikanta Das have repeatedly assured the market of liquidity support, the central bank has been conducting variable rate reverse repo auctions to ensure that the cost of short-term borrowings does not fall below that floor rate, which is currently at 3.35%.
Over time, the idea is to push up the rate at which liquidity is absorbed via these variable rate reverse repo auctions, which would make it easier for the central bank to eventually raise that benchmark.
The size of the liquidity surplus, however, has drowned out the impact of recently conducted auctions, Kaushik Das, chief India economist at Deutsche Bank, said in a report dated Sept. 7, 2021.
According to the report:
In January 2021, when the RBI had re-started the VRRR auctions, the cut-off rate for the Rs 2-lakh-crore 14-day auction was at 3.54%. At that time, the surplus was around Rs 6.4 lakh crore.
In the last VRRR auction of Rs 3 lakh crore for a 14-day tenor on Aug. 27, the cut-off rate moderated to 3.42%, as the liquidity surplus had increased above Rs 8.5-9.0 lakh crore by end-August. It was higher than the Rs 11 lakh crore including government cash balances.
The recently announced additional VRRR auction of Rs 50,000 crore for a seven-day tenor has seen a cut-off rate of 3.38%, close to the reverse repo rate of 3.35%.
If the action is unlikely to impact market dynamics or provide a monetary policy signal, why announce it then?
According to Kaushik Das, an “ever-cautious“ RBI is testing the market reaction before it announces longer-term liquidity absorption in the October policy.