In response to the sharp outflows of advance taxes, the Reserve Bank of India (RBI) has decided to conduct a three-day auction of Variable Rate Repo (VRR) bonds of Rs 1 lakh crore to open up the banking system. The auction will be held on 19 June with the funds maturing on 22 June, the RBI notification said.
Key Highlights
- RBI to conduct Rs 1 lakh crore VRR auction after liquidity surplus sharply declines.
- Advance tax outflows push banking system liquidity to lowest level since March.
The measure is being taken after surplus liquidity in the banking system declined significantly by Rs 23,881 crore to Rs 4,772 crore on June 17, the lowest level of surplus liquidity since the end of March. The decrease is due to the effect of advance tax payment, where advance tax is paid before the tax is collected, and temporarily withdraws money from the banking system and accumulates in the government's account with the RBI.
Advance Tax Payments Trigger Liquidity Crunch
The surge in advance tax outflows was cited by the market as the main reason behind the sharp drop in flow, which is a regular occurrence every quarter that restricts the liquidity of the banking system for a certain time.
According to the latest data from the RBI, the liquidity surplus has come down significantly from being at a comfortable level of nearly Rs 1 trillion for the past almost three months. The squeeze has also increased the overnight funding costs pushing weighted average call money rate (WACR) to above the policy repo rate of 5.25% set by the central bank, suggesting higher short-term fund demand by banks.
The central bank said the decision to carry out the VRR auction was made taking into account the liquidity situation prevailing in the financial system and changing over the period.
Also Read: Banking Liquidity Surplus Drops to FY27 Low at Rs 23,881 Crore
RBI Continues Liquidity Support Measures
This is the most recent of the liquidity support measures by RBI to facilitate the monetary policy transmission and ensure sufficient liquidity in money markets.
The central bank has pumped in almost Rs 1.89 lakh crore in the last few days through various VRR auctions of differing tenures. This comprised of Rs 89,440 crore worth of bids under 7-day VRR auction on June 16 and Rs 28,220 crore of bids under an Overnight auction on June 15.
Moreover, the RBI had injected a total of Rs 72,300 crore through two separate VRR operations to resolve the short-term liquidity challenges on June 18, highlighting the proactive steps being taken by the RBI to manage the short-term liquidity issues.
Focus on Stable Money Market Rates
The recently announced Rs 1 lakh crore auction is likely to provide some short-term liquidity support and stabilise the money market short rates, thus averting liquidity pressures on the money market caused by tax-related pressures.
It comes after the RBI implemented several policy measures including cutting repo rate by 50 basis points to boost economic growth and the Cash Reserve Ratio (CRR) to ease liquidity conditions in the banking system.
Liquidity Expected to Improve
Experts say the current liquidity squeeze is short-lived, as government spending will gradually resume in the economy in the next few weeks. Seasonal tax fears are likely to pose no challenge to funding conditions as the RBI keeps pumping money into the system, ensuring financial markets and banks have enough funds to operate.
