The variable rate repo (VRR) auction by the Reserve Bank of India (RBI) witnessed an overwhelming response from banks, highlighting the growing demand for liquidity in the banking sector. Banks submitted bids worth ₹1,13,915 crore, significantly exceeding the RBI’s offer of ₹50,000 crore.
At all VRR auctions, barring one, conducted by RBI in the current month so far, the demand for funds has been more than the notified amount. At the May 3 VRR auction, the demand for funds (₹1,57,698 crore) was lower than the notified amount (₹1.75-lakh crore).
Currently, liquidity in the banking system is estimated to be in deficit of around ₹1.54-lakh crore. But experts suggest that the situation will change with RBI’s ₹2.1 trillion dividend transfer to the government coupled with the cancellation of weekly treasury bill auctions of ₹60,000 crore.
FX intervention
“Over coming weeks, we see the RBI’s FX intervention strategy as the main driver of interbank liquidity and this should largely be driven by the election outcome. FPI accounts have resumed buying India Government Bonds (IGBs) over the past few weeks, though in small sizes for now. However, beyond the FX channel, we should start to see inflows from GOI redemptions, interest payments and lower T-bill issuance. Under our base case, we can see interbank liquidity entering into a surplus by July,” Nomura said in a recent note.
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Since the middle of December, the RBI has been conducting VRRs to inject liquidity on a temporary basis into the banking system. In mid-January, it increased the tenor of the VRR to 14 days to match the CRR cycle and this has become a steady State injection. Further to this, it has been conducting short-dated VRRs (1-7day) periodically to ‘fine tune’ market liquidity.
“Should banking liquidity evolve in line with our projections, we believe the RBIs use of the VRR tool will decline. Liquidity moving into a surplus would bring back VRRRs into the frame and this would stop Mumbai Interbank Offer Rate (MIBOR) moving below the repo rate (6.5 per cent), unless there is a change of strategy/stance from the RBI,” Nomura said.