RBI Skips 14-Day VRR Auction
Variable Rate Repo – Liquidity Management Tool Skipped Amidst Market Speculation
Context: In a move that has stirred market speculation, the Reserve Bank of India (RBI) has once again skipped its key liquidity management tool—the 14-day variable rate repo (VRR) auction—for the fortnight from April 17 to May 2.
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- This marks the third consecutive fortnight the central bank has opted out of the operation, raising questions about a possible change in the RBI’s liquidity management framework.
- The RBI cited a review of “evolving liquidity conditions” as the reason for not conducting the auction.
Repo and Reverse Repo Rates
Repo Rate: The repo rate is the interest rate at which the RBI lends money to commercial banks when they face a shortfall of funds. Banks borrow from the RBI by selling government securities with an agreement to repurchase them at a future date, hence the term repurchase agreement or repo.
Reverse Repo Rate: The reverse repo rate is the interest rate at which the RBI borrows money from commercial banks by accepting their surplus funds for a short term, paying them interest in return. When banks have excess liquidity, they can deposit funds with the RBI at the reverse repo rate, which is a safe investment option for them.
About Variable Rate Repo (VRR)
- It is a monetary policy tool used by the Reserve Bank of India (RBI) to manage short-term liquidity in the banking system.
- Unlike the fixed repo rate, which is predetermined by the RBI, the VRR is determined through market-based auctions where banks bid for funds, making the interest rate variable and market-driven.
Key Features
- Market-Determined Rate: Interest rates for VRR are set by competitive bidding in auctions, reflecting current market demand and supply conditions.
- Flexible Tenure: VRR loans typically range from 2 days up to 14 days or sometimes longer, providing banks with more flexibility compared to the usually overnight fixed repo rate.
- Liquidity Management: VRR helps the RBI inject liquidity into the banking system when there is a shortage of funds, or absorb excess liquidity when there is surplus money, thereby stabilising the financial system and controlling inflation.
- Dynamic Adjustment: The VRR rate fluctuates based on market conditions, unlike the fixed repo rate which remains constant until RBI revises it during monetary policy meetings.
Role in Monetary Policy
- When liquidity is tight and call money rates rise above the repo rate, the RBI conducts VRR auctions to inject funds at a rate usually just above the policy repo rate.
- Conversely, when there is excess liquidity, the RBI uses Variable Rate Reverse Repo (VRRR) auctions to absorb surplus funds.
