Tezzbuzz Desk – At present, there is a situation of excess cash i.e. surplus liquidity in the Indian banking system. Due to increasing inflow of FCNR(B) deposits and foreign capital, banks have excess funds available. To control this excess cash and keep the interest rates stable in the money market, the Reserve Bank of India (RBI) has resorted to VRRR i.e. Variable Rate Reverse Repo auction. In fact, when the cash in the banking system increases more than required, banks start lending that extra amount to other banks at lower interest rates. This may put pressure on short-term interest rates and they may go below the policy repo rate of RBI. In such a situation, the effect of the monetary policy of the central bank may weaken. Therefore, it is necessary for RBI to absorb excess liquidity from time to time.
VRRR auctions are an important tool used for this purpose. Under this, commercial banks deposit their excess cash with RBI for a fixed period. In return they get interest. In this, the interest rate is not completely fixed in advance, rather banks bid their rates during the auction. For this reason it is called Variable Rate Reverse Repo. In the current situation, the role of FCNR (B) deposit is very important. After the special swap window of RBI, a record amount of $ 127 billion was deposited in banks under this scheme. This large inflow of foreign currency also created additional liquidity in the form of rupees in the banking system. Apart from this, government spending and other capital flows have also affected the availability of cash in the system.
One reason for controlling excess cash is the risk of inflation. If there is excess money available in the market for a long time, demand may increase and there is a possibility of pressure on prices. Although additional banking liquidity alone does not mean that inflation will rise immediately, RBI has to keep an eye on the potential risks. Through VRRR, RBI tries to ensure that short-term rates like overnight call money and TREPS remain near the policy repo rate. This improves the transmission of monetary policy and helps limit unnecessary fluctuations in the financial markets.
However, VRRR is not the only option available with the RBI. If necessary, the central bank can make temporary changes in CRR or use other liquidity management measures. Interventions in the foreign exchange market can also affect the liquidity of the banking system.
In the coming time, the excess liquidity in the system may be reduced due to increased demand for cash during festivals, maturity of forward contracts and possible forex operations of RBI. In such a situation, the biggest challenge before the central bank will be to maintain a balance between inflation and interest rates while supporting economic growth. Overall, VRRR auction is an important means for RBI to systematically absorb the excess cash present in the banking system. Its objective is not to block funds from banks, but to maintain a balance between liquidity and interest rates in the market.