Context

With the banking system liquidity slipping into a deficit, the Reserve Bank of India (RBI) will conduct an overnight variable rate repo auction (VRRR) for Rs 50,000 crore.

About

What is Variable rate repo auction?

• The VRRR is usually undertaken to reduce the money flow by taking out existing cash present in the system.
• The central bank performs it to rebalance the surplus liquidity in the system by shifting it out of the fixed-rate overnight reverse repo window to VRRR auctions of longer maturity.

Repo rate: Repo rate is the rate at which the central bank of a country (Reserve Bank of India in case of India) lends money to commercial banks in the event of any shortfall of funds. Repo rate is used by monetary authorities to control inflation. Reverse Repo rate: A reverse repo is a rate at which RBI borrows money from banks. RBI borrows a part of this money at a fixed rate and some of it at variable rate.

What is the role of RBI?

• Under the Reserve Bank of India, Act,1934 (RBI Act,1934) (as amended in 2016), RBI is entrusted with the responsibility of conducting monetary policy in India with the primary objective of maintaining price stability while keeping in mind the objective of growth.
• RBI controls the flow of money through repo rates and reverse repo rates.
• It plays multi-facet role by executing multiple functions such as overseeing monetary policy, issuing currency, managing foreign exchange, working as a bank of government and as banker of scheduled commercial banks, among others.
• It also works for overall economic growth of the country.

Analysis

Why there is a need for auctioning the rate repo?

• The Reserve Bank does a continuous rebalancing the liquidity conditions in a non-disruptive manner while maintaining adequate liquidity to meet the needs of the productive sectors of the economy.
• With larger than anticipated collections under the goods and services tax (GST), system liquidity has tightened.
• Banks have been borrowing increasing amounts from the marginal standing facility (MSF).
• The call money rate has reduced below the repo rate.
• This is also reflected in the hardening of overnight money market rates, and in amounts under the fixed rate reverse repo of the liquidity adjustment facility (LAF).

Liquidity Adjustment Facility (LAF) is a tool used in monetary policy by the RBI that allows banks to borrow money through repurchase agreements (repos) or for banks to make loans to the RBI through reverse repo agreements.

Factors affecting inflow of money

• Economic activity can influence market trends, for the better or for the worse.
• Government policy and geopolitical events are factors that can lead to either stability or instability in markets.
• Market participant expectations and the natural balance of supply and demand are other important factors.

What will happen after auctioning VRRR?

• RBI will infuse liquidity through different tools like variable repo etc. and the liquidity that has gone out due to advance taxes and the goods and services tax will flow back into the system.
• Further, the coming festive season can boost the economic imbalances, as estimated.
• Liquidity will stay around neutral levels as Inflation will be brought into control via repo operations.

Suggestive measures

• Balancing Inflation for sustained benefits after auction.
• Cash reserve ratio (CRR) to be balanced.