RBI withdraws ₹6 trillion following spike in bank liquidity: Will interest rates go up?
Despite the RBI's efforts, VRRR auctions have seen tepid bank participation which can lead to a potential rate hike during its next monetary policy review
The Reserve Bank of India has absorbed more than ₹6 trillion through Variable Reverse Repo Rate (VRRR) auctions to manage a significant surge in bank liquidity, which hit ₹11.6 trillion on September 6, driven by substantial forex inflows. Despite the RBI's efforts to temporarily withdraw excess funds via VRRR auctions, bank participation has been tepid, with bid amounts falling short of notified amounts. This situation, coupled with the potential for unchecked liquidity to fuel inflation and depress interest rates, suggests the RBI may consider a rate hike during its next monetary policy review to stabilize the repo rate and control inflation.
The Reserve Bank of India has absorbed more than ₹6 trillion through Variable Reverse Repo Rate (VRRR) auctions to manage a significant surge in bank liquidity, which hit ₹11.6 trillion on September 6, driven by substantial forex inflows. Despite the RBI's efforts to temporarily withdraw excess funds via VRRR auctions, bank participation has been tepid, with bid amounts falling short of notified amounts. This situation, coupled with the potential for unchecked liquidity to fuel inflation and depress interest rates, suggests the RBI may consider a rate hike during its next monetary policy review to stabilize the repo rate and control inflation.
The Reserve Bank of India has absorbed more than ₹6 trillion through Variable Reverse Repo Rate (VRRR) auctions to manage a significant surge in bank liquidity, which hit ₹11.6 trillion on September 6, driven by substantial forex inflows. Despite the RBI's efforts to temporarily withdraw excess funds via VRRR auctions, bank participation has been tepid, with bid amounts falling short of notified amounts. This situation, coupled with the potential for unchecked liquidity to fuel inflation and depress interest rates, suggests the RBI may consider a rate hike during its next monetary policy review to stabilize the repo rate and control inflation.
The Reserve Bank of India on Monday absorbed more than ₹6 trillion through Variable Reverse Repo Rate (VRRR) auctions following a surge in bank liquidity.
On September 6, India’s banking system liquidity hit a surplus of ₹11.6 trillion. The spike was driven by an overwhelming forex inflow of around $136 billion that entered the system under RBI’s swap facility. The RBI’s FCNR(B) scheme alone gathered around $127 billion and closed on August 30.
The FCNR(B) scheme allowed Non-Resident Indians (NRIs) and Persons of Indian Origin (PIOs) to maintain fixed deposits in approved currencies with banks in India.
While this can increase credit growth, an unchecked flood of foreign money in the banking system means that banks have plenty of cash to lend. This can lead to a rapid increase in borrowing, spending and economic activity, threatening to drive up asset prices and increase inflation.
Hence, the RBI has been conducting VRRR auctions that allow the central bank to temporarily withdraw extra money from the banking system. Through the auction, banks can deposit their money with the RBI at auctioned interest rates. VRRRs ranging from overnight to 14-day maturity were conducted. Longer-tenor auctions see less interest as banks don’t want to park funds for prolonged periods.
However, the auctions have been seeing tepid responses from the banks, with the total amount of offers received being well below the notified amount. The 30-day VRRR on September 7 received only ₹2.59 trillion, compared to the notified amount of ₹7 trillion.
For the overnight VRRR on September 7, the RBI received offers worth ₹3.53 trillion compared to the notified amount of ₹5 trillion. The bids were accepted at a weighted average rate of 5.24 per cent. In total, the central bank withdrew around ₹6 trillion through both auctions.
Five traders told Reuters that bank participation was weak due to technical glitches. However, another person familiar with the matter said that there were no glitches in RBI’s e-Kuber system, which is used for such auctions.
If the surplus liquidity is not managed, interest rates will eventually go up. The RBI currently maintains its benchmark repo rate at 5.25 per cent. However, when banks are flooded with excess cash, they stop borrowing from one another and aggressively lend out short-term money. This makes credit cheaper and well below the repo rate. To stabilise the repo rate and to control inflation, the central bank is highly likely to hike rates during the the next MPC review on October 5-7.