Banking system liquidity surplus tops ₹4 trillion; strong VRRR demand

Liquidity jumps on government spending and surplus transfer; RBI gets ₹1.7 tn bids at 7-day VRRR, with cut-off at 5.47%; experts see preference for shorter operations

The liquidity surplus in the banking system, measured by lenders parking funds in the Reserve Bank of India’s (RBI’s) liquidity adjustment facility (LAF), surged to ₹4.04 trillion on Thursday, highest since May 19, 2022.

 

The spike is mainly due to increased government spending, following a record ₹2.69 trillion surplus transfer by the central bank in May.

 

During the seven-day Variable Rate Reverse Repo (VRRR) auction conducted on Thursday, the RBI received bids worth around ₹1.7 trillion against a notified amount of ₹1 trillion. The central bank accepted ₹1 trillion at a cut-off rate of 5.47 per cent.

 

The bidding was significantly higher compared to last week’s auction, where the RBI had received bids worth ₹84,975 crore against a notified amount of ₹1 trillion. 

 

“The bids were lower in the previous auction because it was held during the end of the quarter. In the latest auction, the liquidity situation is much different. The surplus liquidity is expected to remain above ₹4 trillion in the near term,” said V R C Reddy, Head of Treasury at Karur Vysya Bank. 

 

VRRR auctions are aimed at absorbing excess liquidity from the banking system and aligning overnight rates with the repo rate. The surplus liquidity has kept the overnight weighted average call rate near the Standing Deposit Facility (SDF) rate of 5.25 per cent and below the repo rate of 5.50 per cent.

 

Dealers said it remains to be seen whether the RBI would conduct daily VRRR auctions and raise the notified amount if it wants to align the Weighted Average Call Rate (WACR) — the operating target of monetary policy — with the repo rate of 5.5 per cent.

 

On Friday, the WACR rose to 5.29 per cent from 5.26 per cent the previous day, while the weighted average overnight TREPS rate increased to 5.18 per cent from 5.12 per cent.

 

The recent improvement in banking system liquidity can largely be attributed to higher government spending and lower-than-expected goods and services tax (GST) collections, which have eased typical liquidity pressures. As a result, the liquidity drain was not as sharp as anticipated, experts said. With the RBI having already reduced the cash reserve ratio, its room to deploy other liquidity withdrawal measures, apart from VRRR, is limited, they added.

 

The RBI is expected to stick to shorter-tenure VRRR operations to avoid overlap with upcoming GST outflows, they further noted.

 

VRRRs of less than 14 days are considered fine-tuning operations for short-term liquidity management, in contrast to longer-tenure auctions that impact durable liquidity. Since the central bank is keen to improve transmission of the 100-basis-point repo rate cut in this easing cycle, it is unlikely to absorb durable liquidity for now.