The Reserve Bank of India (RBI) is turning to longer-dated variable rate reverse repo (VRRR) auctions as it steps up efforts to withdraw surplus liquidity from the financial system, a move that comes amid mounting inflationary pressures in the economy.

The central bank's latest liquidity mop-up follows a notable shift in money market conditions: call money rates have slipped below the policy repo rate, a signal that cash is abundant in the banking system. Forecasts now suggest that systemic liquidity could exceed ₹15 lakh crore (fifteen lakh crore) by the close of September.

In a related liquidity management operation, the RBI recently sold government securities worth ₹32,000 crore (thirty-two thousand crore), further reinforcing its efforts to drain excess cash from the system.

The VRRR is a standard tool in the RBI's liquidity management toolkit. Under this facility, banks park their surplus funds with the central bank at an interest rate determined through auction, and the 'variable rate' mechanism allows the RBI to control how much liquidity it absorbs at each operation. Longer-dated VRRR auctions lock in funds for extended tenors, giving the central bank a more durable grip on surplus cash than shorter overnight or near-term operations. The RBI has relied on VRRR auctions extensively in the past when durable surpluses built up in the system, including in the years following the pandemic-era liquidity injections.

By draining excess liquidity, the RBI aims to keep short-term rates aligned with its policy stance and to contain inflationary pressures, since abundant cash in the banking system can keep money market rates soft and dilute the transmission of monetary policy. Persistent surpluses of the scale now forecast matter beyond money markets: they can influence short-term borrowing costs for banks and corporates and shape conditions in bond and credit markets.

For market participants, the effectiveness of these operations will be visible in whether call money rates move back toward the repo rate and whether the projected surplus materialises by end-September.

Source: Economic Times Markets