The Reserve Bank of India’s (RBI) plan to inject liquidity into the banking system through daily variable rate repo (VRR) auctions is expected to ease overnight interbank and money market rates, traders said Thursday. However, yields on long-duration government bonds are likely to remain largely unchanged due to unmet demand for durable liquidity, according to investors.
Background and Importance
The banking system has faced a liquidity crunch over the past month, with core liquidity—factoring in government cash balances—moving into deficit. This has driven overnight borrowing costs significantly higher, indirectly pushing up rates on short-term instruments like commercial papers, certificates of deposit, and treasury bills.
To address these pressures, the RBI announced on Wednesday that it will conduct daily overnight VRR auctions on working days starting Thursday. The measure is aimed at easing immediate liquidity strains.
Current Liquidity Conditions
The banking system has been in liquidity deficit since mid-December, with an average daily shortfall of approximately ₹1.65 trillion ($19.08 billion). Elevated overnight borrowing costs have underscored the urgency of RBI’s intervention.
Market Impact
Following the announcement, short-term rates showed signs of easing:
The three-month treasury bill yield fell by five basis points to 6.55%.
Yields on three- to five-year bonds dropped six to seven basis points to approximately 6.70%.
The 10-year benchmark bond yield saw a modest decline of three basis points to 6.78%.
Investor Perspective
Despite the expected relief in short-term rates, the market for longer-dated government bonds remains constrained by the lack of durable liquidity. Investors believe the VRR auctions address immediate liquidity needs but fall short of providing a structural resolution to liquidity deficits.
The RBI’s ongoing liquidity measures will be closely monitored, especially as the banking system grapples with the challenges of balancing liquidity and borrowing costs.
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