VARIABLE REVERSE REPO RATE (Syllabus: GS Paper 3 – Economy)

Context: Recently, the Reserve Bank of India conducted a two-day variable rate reverse repo (VRRR) auction as the liquidity surplus in the banking system approached Rs 1 trillion.

Variable Reverse Repo Rate (VRRR)

• About: It  is a monetary tool used by central banks to manage liquidity within the banking system.
• Implementation: Since January 2021, RBI has employed VRRR auctions, intensifying the frequency to 14 days in August 2021.
• Future Directions: In December, RBI hinted at utilizing longer-term VRRRs without disclosing specifics on size and maturity, signifying its pivotal role in liquidity management.
• Focus: RBI indicates a shift towards using VRRR auctions as its primary liquidity management operation.

Significance

• Liquidity Absorption: Given surplus liquidity estimated at Rs 9.5 lakh crore in October 2021, VRRR serves as a crucial tool alongside reverse repo rates to absorb excess funds effectively.
• Long-term Solutions: Long-term VRRR options offer potential avenues for liquidity management, with the possibility of increasing auction sizes and tenors.
• Impact on Banking Products: Banks incentivized by long-term VRRR may offer higher interest rates on fixed deposits, potentially influencing returns on short-term products like overnight and liquid funds.

Variable Repo Rate

• About: It comes into play when the RBI aims to inject liquidity into the economy, but banks show reluctance to borrow from the RBI at the Repo Rates. This scenario usually occurs when interest rates in the economy are already low.
• Purpose: The VRR allows banks to borrow from the RBI at a rate determined by the market, typically lower than the Repo Rate (but not less than the Reverse Repo Rate). This borrowing can extend beyond a one-day duration.