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Informist, Wednesday, Jun. 11, 2025

 

By Siddhi Chauhan and Aaryan Khanna

 

MUMBAI – As the Reserve Bank of India closes the chapter on daily variable rate repo auctions Wednesday, money market traders fear it is a signal that the central bank is aiming for overnight rates to settle near the policy repo rate of 5.50%. Over the last three weeks, overnight money market rates have been at or below the Standing Deposit Facility rate, 25 basis points below the repo rate. 

 

Mathematically, the move doesn't make a material difference – RBI Governor Sanjay Malhotra noted that daily VRR auctions have had subscription of only 0.26 times between April and Jun. 4. In June, the average daily borrowing by banks and primary dealerships through the daily VRR auction was INR 42.42 billion, against the notified amount of INR 250 billion each day. Even the largest borrowers left at these auctions – primary dealerships – shrugged off the impact of the move, saying they would approach money markets for cheaper funds.

 

But the withdrawal of daily VRRs has sparked concern among traders about the RBI's comfort with overnight rates, soon after the central bank's Monetary Policy Committee cut the policy repo rate by 50 basis points to 5.50% but changed its stance to 'neutral' from 'accommodative' in a single meeting.

 

With the commentary and now this action following the policy, the call market rate may be heading to the repo rate rather than the lower end of the policy corridor, dealers said. This is likely to have a significant impact on the pricing of debt instruments, and may push the Treasury bill cut-offs on week Wednesday and lead to repricing of gilts maturing within three years, yields on which had collapsed after the MPC's jumbo rate cut.

 

"I feel because the stance has been changed to neutral, the RBI doesn't want the operating rates to be below the repo rate," a dealer at a primary dealership said. "They might want the rates to be at the repo rate level."

 

Through its liquidity operations, the central bank had effectively introduced a 'shadow rate cut' by maintaining the call market rate near the lower end of the Liquidity Adjustment Facility corridor for the past month. Daily VRRs had long stopped providing meaningful liquidity, but gave borrowers certainty since they were announced on Jan. 15 that there was a backstop to meet short-term mismatches, dealers said. Four months later, the ambiguity in Governor Malhotra's comments on where he wanted overnight market rates to settle led several traders to expect an end to the operation, which had been introduced as a time of systemic liquidity deficit when the MPC's stance was neutral.

 

"We have not really given it a thought on that, so we'll decide and you'll come to know in the coming few days – I will not be able to give you a very precise answer," Malhotra has said on Friday. "But having the policy (rate) at 5.5% and the stance now going to neutral, all that will come in the picture – we will take a call on where we will try to have the call rate."

 

Until Monday, when the RBI announced the end of daily VRR auctions, the proxy for banking liquidity surplus has averaged INR 2.68 trillion in June. According to data from RBI, funds parked under standing deposit facility were at INR 2.59 trillion Monday, up from INR 1.96 trillion on Sunday. Crucially, this overhang is expected to come down in the coming days as outflows for advance tax and goods and services tax drain cash from banks to the exchequer.

 

"I feel that outflows for this month would amount to somewhere around INR 3.2 trillion to INR 3.5 trillion," a dealer at a state-owned bank said. "Even then, I am confident that surplus will be around INR 1 trillon by the end of the month. Every day, more than INR 2 trillion are parked under SDF. Yes, money market rates will rise but it won't rise sharply beyond the repo rate."

 

To be sure, asset-liability managers and money market traders are not worried at all that liquidity will tend to neutral or a deficit. The government will pay out over INR 800 billion on Monday, matching the day of the advance tax outflows, for the maturity of the 5.22%, 2025 bond. The bulk of it will find its way to the banking system, though the RBI holds some stock of the gilt, dealers said. 

 

"The market will panic only if the operating rate goes above the MSF (marginal standing facility) rate (of 5.75%)," the dealer from the primary dealership said.

 

NEXT STEPS

The majority of the market believes the central bank will be in a 'wait and watch mode' until the call rate goes up to 5.50%, the policy repo rate. Though the RBI governor had mentioned the possibility of variable rate reverse repo operations, the natural drain in liquidity should be enough to push up overnight market rates organically above the Standing Deposit Facility rate that it has occupied even in the two days after the rate decision.

 

"I don't think there is any case to be made for VRRRs right now. They have committed to keeping liquidity in surplus and that will undo all their work," a chief dealer at a primary dealership said. "They will maintain accommodation for an extended period on the liquidity front, it looks like."

 

With the size of the outflows coming up, the central bank is likely to announce short-term VRRs of up to five days to help the market tide over the bump, though a large chunk of that should be met with bank's cash balances already parked at the SDF, dealers said. The RBI is likely to keep the size of the operation large to ensure the cut-off rate is at the mininum 5.51%, and overnight rates are anchored near the repo rate, they said.

 

If the size of the VRRs is low and money market rates approach the marginal standing facility rate of 5.75%, the central bank may up its ante and bring back open market operations to buy gilts and infuse liquidity by expanding its balance sheet, dealers said. The central bank was not seen comfortable adding further liquidity to the system on a durable basis after over INR 9.5 trillion injected through various tools since January. Its announcement of a cash reserve ratio cut for banks is also expected to add INR 2.5 trillion in liquidity over nearly four months from September, a signal that the RBI wants to space out further liquidity support, dealers said. 

 

The central bank may also return to 14-day VRR operations on a regular basis, after conducting its main operation under its current liquidity management framework only once since Mar. 7, dealers said. While funds are easily available for banks, which had excess statutory liquidity ratio securities with them, primary dealers used to borrow from daily variable rate repo auction due to operational hitches in the money market, such as counter-party exposure limits and restrictions on pledging certain securities. Some primary dealers are preempting their funding requirements in the term money market for 15 days, even above the marginal standing facility of 5.75%.

 

"On Tuesday, in the term repo, a deal for 15 days has been struck, likely from primary dealerships. They are willing to borrow at 5.75?cause they feel rates might rise in the coming days," a dealer at a private sector bank said. "This indicates that if RBI come with a 14-day VRR, they might see demand not only from small PSUs who are keen to borrow for long term requirements, but also from primary dealers."  End

 

Edited by Avishek Dutta

 

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