RBI Takes Another Small Step Towards Normalisation

The Reserve Bank of India took another step towards normalisation of its liquidity policies, announcing the first longer-term auction to absorb liquidity.

The central bank will conduct its first 28-day variable rate reverse repo auction on Nov. 2, 2021, it announced on Wednesday. The VRRR will be conducted for Rs 50,000 crore.

So far, the RBI has absorbed liquidity using up to 14-day VRRR auctions. These are typically seen as short-term liquidity management.

At its policy meet earlier this month, RBI Governor Shaktikanta Das had announced a step-up in the pace of variable rate reverse repo auctions and the option of 28-day VRRR auctions. "Depending upon the evolving liquidity conditions—especially the quantum of capital flows, pace of government expenditure and credit offtake—the RBI may also consider complementing the 14-day VRRR auctions with 28-day VRRR auctions in a similar calibrated fashion," Das had said.

What's The Signal?

This is the clearest signal from the RBI that the central bank now wants to transition into dealing with liquidity management on a durable basis, albeit in a staggered and non-disruptive manner, said Kaushik Das, chief India economist at Deutsche Bank.

"Now with longer-tenor VRRR becoming operational, we are more confident of our call of a reverse repo rate lift-off starting from December 2021 monetary policy," Das said.

Deutsche Bank is expecting a 20-basis-point hike in the reverse repo rate to 3.55% in December.

Rahul Bajoria, chief India economist at Barclays, said while one can interpret the introduction of 28-day VRRRs as a signal, it is not something that will have a material market moving impact because interest rates have already adjusted upwards.

The amounts involved are small, he said. While the latest announcement is for Rs 50,000 crore, the overall amount that the central bank is absorbing is close to about Rs 7 lakh crore.

"Overnight rates have already increased and the weighted average cost of reverse repo is already close to 4%. Effectively, it signals that there has already been a shift in the markets," Bajoria said.

If the RBI was to start raising the reverse repo at its December meet, they will basically be raising the rate on the fixed rate reverse repo window, he explained. This will not have much impact as overnight rates have already risen.

To be sure, the RBI is still taking baby steps in normalising its stance and remains highly accommodative.

The measures should not be seen a reversal of the accommodative policy stance, the governor had said in October. The RBI will ensure that there is adequate liquidity to support the process of economic recovery, he said.