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Informist, Wednesday, Jun. 25, 2025

 

By Aaryan Khanna and Siddhi Chauhan

 

MUMBAI/NEW DELHI – The Reserve Bank of India Tuesday announced a variable rate reverse repo auction after more than two weeks of speculation over when, not if, the central bank would deploy the tool. The move is seen mopping up an excessive build-up of liquidity and does not immediately threaten overnight call money market rates heading to the repo rate of 5.50%, according to market participants.

 

The central bank will hold a seven-day VRRR auction for INR 1.00 trillion on Friday, its first such auction since November. RBI Governor Sanjay Malhotra's mere mention of the VRRR auction spooked traders on Jun. 6, even as the governor said overnight rates should remain at the lower end of the policy corridor of 5.25% if the tool was not deployed. The weighted average call rate has been gliding towards that level, where the RBI deploys its Standing Deposit Facility, since the policy outcome.

 

The weighted average call rate, which is the operating target of monetary policy, was 5.27% on Tuesday. A massive liquidity surplus provided by the RBI during the COVID-19 pandemic had led to overnight rates falling below the effective policy rate of 3.35%, the lower bound of the policy corridor then, in 2020 and 2021.

 

"The INR 1 trillion amount is similar to what the market was expecting," a bond dealer at a private sector bank said. "This just looks like it is anchoring the rate at the SDF proactively instead of allowing the call rate to go out of the policy corridor in the first week of July due to the massive liquidity surplus."

 

Malhotra had said in April the central bank would look to maintain a systemic surplus of around 1% of banks' net demand and time liabilities, which, according to the latest data, would indicate a surplus of around INR 2.30 trillion. Despite scheduled tax outflows over the last 10 days draining over INR 3.00 trillion from banks, the RBI's net liquidity absorbed from the banking system Monday--a proxy for the systemic liquidity surplus--was INR 2.44 trillion. The move seemed imminent after the hefty outflows were done, but the timing was a week sooner than most in the market expected, dealers said.

 

Both the weighted average call rates and weighted average triparty repo rate are likely to rise by 5-8 basis points to around 6.35% and 6.25%, respectively, market participants said. Banks will be keen to park excess funds at the VRRR auction to earn another 20 bps over the prevailing call money rates, inevitably driving those up. The maximum cut-off rate at the VRRR auction, at 5.49%, is also well above the SDF rate of 5.25% that banks currently get for parking excess funds overnight with the RBI.

 

"It seems that the RBI is aware that inflows from month-end spending will be more than what we are expecting," a call market dealer at another private sector bank said. "This could be the possible explanation why they (RBI) chose to come up with VRRR now instead of July." Inflows from the government's usual month-end spending are already expected to drive the system surplus up to around INR 3.50 trillion in the coming days, and any excess could drive the surplus to levels last seen in June 2022.

 

The auction size of INR 1 trillion will only drain enough liquidity to keep overnight rates within the Liquidity Adjustment Facility corridor as over INR 2.5 trillion would still be available in the banking system, dealers said. The seven-day auction will be held on a reporting Friday, where banks tend to maintain higher cash buffers to meet reporting requirements. It will also straddle the June quarter end on Monday, when funding requirements are already tight, bankers said. This will prevent exuberance from both state-owned and private sector lenders, they said.

 

The result of the auction will set the tone for overnight rates, with a higher subscription raising expectations of higher money market rates. Consensus expectations immediately after the announcement suggest subscription will likely be 50-70% of the notified amount. Uncertainty still persists over whether the VRRRs would become a regular feature, or whether it is a one-off course correction as government spending transfers high durable liquidity to the banking system, market participants said. The net durable liquidity surplus as of May 30 stood at INR 5.85 trillion, the highest level since Aug. 1, 2022, according to the latest data.

 

"First there was an expectation, then that died out, and now this came a little bit out of the blue," a senior treasury official at a state-owned bank said. "We'll only know where funding costs will go after the auction, but it will definitely be above the SDF rate from here on."

 

FLATTER YIELD CURVE

While call money rates may consider the expected rise minimal, the government's short-term debt and bonds maturing by early 2028 will see a sharp rise in yields on Wednesday. In contrast, bonds like the 10-year benchmark may only rise 2-3 bps.

 

Treasury bill cut-off yields at the auction on Wednesday are expected to rise by around 8 bps from the prior week, market participants said. The RBI last set the cut-off on the 91-day T-bill at 5.36%, for the 182-day T-bill at 5.46% and the 364-day T-bill at 5.50% on Jun. 18. The entire sovereign yield curve has steepened since the outcome of the Monetary Policy Committee's meeting on Jun. 6, and the spread of the 50-year bond yield over the one-year T-bill was 160 bps last week.

 

"The steepener has played out; now it looks like the short-end will correct," the head of asset-liability management at a third private sector bank said. "The two-year bonds are going to be hit the worst since they haven't sold off, unlike the rest of the curve, so automatically the curve will flatten."

 

The one-year overnight indexed swap rate is also expected to rise on Wednesday from 5.49% Tuesday as traders reprice their expectations of funding costs over the next 12 months. The overnight Mumbai Interbank Offered Rate – the floating leg of the OIS rate – has been set at 5.30% since Jun. 17, and may rise after the VRRR announcement to 5.35-5.40% on some days. The current pricing in the one-year OIS rate shows no rate cuts or hikes, but assumes the funding cost remains static at 5.30%, which may be in jeopardy now, dealers said.  End

 

Edited by Deepshikha Bhardwaj

 

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