RBI repo undersubscribed but banks brace for volatile month-end liquidity

Central bank expected to conduct more variable rate repos towards end of financial year

The 14-day variable rate repo (VRR) auction held by the Reserve Bank of India on Friday was slightly undersubscribed, with banks borrowing funds worth Rs 82,650 crore out of the Rs 1-trillion window the central bank offered.

When the RBI conducts VRR operations, it infuses funds into the banking system. The cutoff at Friday’s auction was set at 6.51 per cent while the weighted average rate was 6.53 per cent.

The RBI has since February resumed repo operations after a five-month pause, as liquidity in the banking system is set to tighten due to year-end tax outflows and the redemption of pandemic-era repo operations it conducted.

According to treasury officials and analysts, banks may have bid for less than the notified amount at Friday’s repo auction due to expectation of a pick-up in government spending towards the end of the financial year as is usually the case.

As on January 27, 2023, the government’s cash balance was at Rs 2.5 trillion, analysts said.

However, an uneven distribution of liquidity in the banking system could result in money market rates turning volatile towards the end of the month as outflows on account of corporate advance tax payments and Goods and Services Tax (GST) coincide with the redemption of long-term repo operations worth a total Rs 12,281 crore in the second fortnight of this month.

“The banking system won’t need much money next week but I see the system short during March 20-24, unless government spending picks up. In the last week of March, typically the government spends, but the skewed nature of the liquidity can lead to higher rates,” said a treasury official with a foreign bank.

“Perhaps the system should have borrowed more in this week’s repo auction. The thought process could have been that for 8-9 days, banks lend back to the RBI at 6.25 per cent (at the Standing Deposit Facility), and then for 4-5 days borrow at 6.75 per cent at the Marginal Standing Facility. That is almost the same as borrowing at 6.5 per cent,” he said.

In March, banking system liquidity has consistently been at a surplus, with the RBI absorbing a daily average of Rs 68,701 crore from banks in the first nine days of the month, central bank data showed. The RBI absorbing funds implies surplus cash lying with banks that is then parked with the central bank. The large prevailing surplus is largely on account of government expenditure flowing into the banking system, money market officials said.

In February, however, the RBI had injected funds on 17 out of 25 working days as heavy sales of dollars by the central bank in the currency market had led to a drain of rupee liquidity, treasury officials said. The RBI intervenes in the foreign exchange market through dollar sales or purchases in order to prevent excess volatility in the exchange rate. The rupee witnessed turbulence last month as several US data sets strengthened the case for the Federal Reserve to keep hiking interest rates.

Government spending notwithstanding, analysts believe that the RBI may conduct more variable rate repo operations in coming weeks in order to prevent sharp spikes in money market rates emanating from the skewed nature of liquidity distribution in the banking system. Often, changes in cash holdings of large banks tend to have a large impact on overall liquidity in the system, analysts said.

“We have the advance tax payments next week. I’m sure ahead of that, if the tightness continues, the RBI would announce another variable rate repo auction. Because followed by advance tax, we have the GST payments, which are currently at a run-rate of around Rs 1.7 trillion. So banks are expecting that there could be more variable rate repo auctions,” said Soumyajit Niyogi, director, India Ratings and Research.