RBI sees tepid demand for VRR auctions as system liquidity crunch eases

Mumbai: The Reserve Bank of India (RBI) saw tepid demand for its variable rate repo (VRR) auctions as liquidity tightness in the banking system has eased following the central bank’s infusion.

Against a notified amount of ₹50,000 crore, RBI received bids amounting to ₹8,375 crore at the 14-day VRR auction, indicating low requirement of funds by banks. The easing fund requirement is also reflected in the lower demand seen in the daily VRR auctions held this week.

Barring Monday (3 March), when RBI saw demand worth ₹16,557 crore against an auction amount of ₹25,000 crore, the demand in the daily VRR auctions, too, fell substantially as liquidity in the system eased 4 March onwards.

Against a notified amount of ₹25,000 crore, the central bank received bids worth ₹5,855 crore on Tuesday, ₹5,089 crore on Wednesday and ₹4,442 crore on Thursday. At the three-day auction today, bids received amounted to ₹3,970 crore.

“Market participants are looking for more durable, long-term liquidity. This is why demand in VRR auctions has been minimal—most are preferring 30-day or longer liquidity that will extend into the next financial year," said Venkatakrishnan Srinivasan, bond market expert and founder and managing partner at Rockfort Fincap LLP. "A 14-day VRR conducted around March 18-20 could see strong demand, given the potential tightness due to outflows at that time.”

The current liquidity infusion should be sufficient until GST and advance tax outflows occur, Srinivasan said. “However, if no further measures are taken, liquidity tightness may persist until April.”

While liquidity has been easing, RBI on Wednesday announced more measures to ease liquidity in the banking system. These include the purchase of government bonds ₹1 trillion under open market operations (OMOs) in two tranches, and a foreign currency buy/sell US dollar/Indian rupee currency swap auction of $10 billion for a tenor of 36 months.

RBI’s liquidity announcements on 5 March worth ₹1.9 trillion “were way more than market expectations”, as per a 6 March report by Union Bank of India. "While in the near term, overall banking system liquidity may face pressures from seasonal tax outflows (GST, advance tax, etc) along with currency leakage, assuming FX-related outflows do not play spoilsport, we may potentially see a shift in core liquidity (ex-government balance) towards a strong surplus by end-Mar 2025 while system liquidity is also estimated to end the year at neutral to surplus levels.” 

The report said the situation could further improve by May, supported by RBI expected to pay a dividend of around ₹2.5 trillion to the government for FY25.

“The latest measures, expected to lift core liquidity to a surplus, suggest that the overall policy stance is clearly accommodative, with an eye on facilitating policy transmission,” said Radhika Rao, executive director and senior economist, DBS Bank. “These steps are pre-emptive ahead of a seasonal squeeze in March, being a fiscal year end, besides other contributing factors,” she said, adding that it could include forex market intervention, tax outflows, volatility in capital flows and currency in circulation.

Also read | RBI’s FX swap auction sees strong demand as system liquidity deficit persists

"Concerted action, which includes tranches of OMOs, VRR auctions and FX swaps besides a CRR (cash reserve ratio) reduction in December, have added more than ₹4 trillion to the domestic banking system yet far,” she added.

The RBI first announced a slew of liquidity measures on 27 January, which included OMOs entailing the purchase of government securities worth ₹60,000 crore in three tranches of ₹20,000 crore each. In addition to a $5 billion swap, the regulator also announced a 56-day VRR auction for ₹50,000 crore. It later announced a three-year buy/sell dollar/rupee swap auction on 21 February worth $10 billion with the objective of meeting the “durable liquidity needs of the system.”

Through the first round of measures, RBI is estimated to have infused at least ₹3.2 trillion into the system, according to a recent report by CareEdge. While these steps have helped improve liquidity, “overall conditions remain tight” and further measures are needed, it said.

The RBI is balancing short-term and long-term liquidity, including using FX swaps for more permanent infusion, Rockfort Fincap’s Srinivasan said, adding that a deficit below ₹1 trillion should be manageable for the market, as larger banks still have sufficient liquidity. 

“How the RBI addresses liquidity for smaller banks and NBFCs remains crucial, as they face greater constraints,” he said, adding that deposit growth lagging credit growth is also adding to the cash crunch for these banks.

The liquidity deficit is estimated to have narrowed from over ₹1 trillion on Monday to around ₹20,000 crore on Tuesday, led by several measures taken by RBI over the past two months to inject durable liquidity into the system, according to market experts. System liquidity has been in deficit since late November 2024. Since then, the deficit widened to peak at over ₹2 trillion in January before easing in February.

Among other factors, liquidity tightness is also expected to have been due to RBI’s repeated interventions in the foreign currency market to protect the rupee against sharp valuation drops. On the other hand, the central bank is keen to keep the liquidity situation comfortable to ensure transmission of the recent policy rate cut. The central bank cut the repo rate by 25 basis points on 7 February—the first cut in five years.

Also read | RBI injects $10 billion via currency swap to ease liquidity deficit in financial system: Report

“A let-up in the global dollar rally saw the rupee post its single highest appreciation since February yesterday, closing below 87.0, de facto lowering intervention pressure in the near term,” Rao said. “Looking ahead, a strong dividend transfer from the RBI in May will also provide a more durable liquidity injection, keeping the overall balance well in surplus.”