Pandemic concerns may have prompted RBI to go slow on liquidity operations

It was widely expected RBI would announce a three-day reverse repo auction of Rs 2 trn, rolling over last such auction conducted on Monday; that did not happen during market hours

The Reserve Bank of India (RBI) on Thursday positively surprised the bond markets by going slow on its liquidity absorption mode, possibly indicating its readiness to not rush towards normalisation amid a pandemic scare.

Generally, the central bank has been rolling over its variable rate reverse repo (VRRR) auctions in order to remove excess liquidity from the banking system. It was widely expected that the RBI would be announcing a three-day reverse repo auction of Rs 2 trillion, rolling over the last such auction conducted on Monday.

The central bank did not do so during the market hours. But after the market closed, it announced a 14-day VRRR of Rs 5 trillion. This was lower than the central bank’s expressed plan of draining the system by Rs 8 trillion through VRRR by this week.

The central bank had on December 31 conducted a 14-day VRRR auction of Rs 7.5 trillion, but the banks parked only Rs 2.67 trillion in that auction.

“Both the 14-day amount and no communication on the 3 day VRRR came as a pleasant surprise to the market. It seems the RBI has now taken a backseat on monetary tightening due to the prevailing covid situation,” said Devendra Dash, senior vice president at AU Small Finance Bank.

“This means the cut-off of 3.99 per cent is not near guaranteed in VRRR auctions,” Dash said. Therefore, short-term money market rates would likely dip in the coming days on RBI liquidity support.

Soumyajit Niyogi, associate director of India Ratings and Research observed that in the environment of long pause on policy rate, the internal liquidity management and market operations of the RBI is assuming a critical central role.

“Impounded system liquidity, rather than permanent sterilisation, gives comfort and flexibility to the banks to operate amidst volatile environments without compromising with the stability in the financial system,” Niyogi said.

Like other global central banks, the Indian central bank is also normalising its pandemic-induced extraordinarily loose monetary policy in stages.

In October, it stopped direct bond purchases, thereby halting its infusion of fresh liquidity in the system. Now, it is draining the system liquidity through VRRR auctions. By choosing a variable rate for reverse repo auction, rather than the fixed rate, the central bank has pushed up the de-facto reverse repo rate to near the repo rate of 4 per cent.

This has resulted in bond yields firming up, pushing the interest rate in the economy. Analysts expect a formal reverse repo hike announcement on the February 9 monetary policy review, while a repo rate hike could come sometime in the second half of this calendar.

But clearly, the central bank does not want to hurry on a rate tightening as the economy has still not registered a healthy recovery. The Index of Industrial production (IIP) grew at its slowest pace since Mar-21 by 1.4 per cent year on year in Nov-21, from 4 per cent in October.

Meanwhile, inflation also quickened to a five month high of 5.59 per cent in December, making the job complicated for the central bank.