RBI steps in with ₹1 lakh crore reverse repo auction to curb excess liquidity

India’s central bank is stepping up efforts to manage the banking system’s surplus cash. On Tuesday, the Reserve Bank of India (RBI) announced that it will conduct a two-day variable rate reverse repo (VRRR) auction worth ₹1 trillion ($11.67 billion) on July 9, aiming to keep short-term interest rates aligned with policy targets.

This is the RBI’s second such operation in just a week. A similar seven-day reverse repo auction for ₹1 trillion was held on July 4. The decision, as reported by Reuters, comes amid a surge in liquidity that has kept interbank lending rates well below the central bank’s benchmark repo rate.

Why is RBI absorbing liquidity?

According to Reuters, liquidity in the banking system stood at a surplus of ₹3.4 trillion as of Monday. That’s a large cushion for lenders, but one that risks pushing short-term interest rates too low.

The RBI uses reverse repo auctions to temporarily withdraw excess funds from banks. It’s part of its toolkit to steer overnight rates, like the Weighted Average Call Rate (WACR), closer to the repo rate of 5.50 per cent.

Currently, the WACR is hovering around 5.26 per cent, near the floor set by the Standing Deposit Facility (SDF) at 5.25 per cent, and well below the repo. The Treps rate, another overnight benchmark, has also dropped to 5.13 per cent.

What’s behind the liquidity glut?

Analysts cited by Reuters say the liquidity overhang is mainly due to higher government spending and lower-than-expected GST collections. This unusual combination has eased the typical mid-year cash crunch.

Adding to the liquidity flood was last month’s 100 basis point cut in the Cash Reserve Ratio (CRR), which freed up about ₹2.5 trillion into the system. That left the RBI with fewer tools for absorbing liquidity, except operations like VRRR.

Strong demand expected from banks

The RBI’s last VRRR auction saw bids totalling ₹1.7 trillion, though the central bank accepted only ₹1 trillion at a cut-off rate of 5.47 per cent. Market participants told Reuters they expect similarly strong demand in Wednesday’s two-day operation, which will mature on Friday.

Reverse repo auctions like these help the RBI fine-tune the money supply without needing to alter the broader policy stance.

Policy backdrop: Cut, pause, absorb

The RBI cut its policy rate by a surprise 50 basis points last month and shifted its stance to “neutral”. Alongside this, it halted liquidity infusions and resumed absorption operations from June 27, after interbank rates dipped below its intended range.

Analysts quoted by Reuters say the RBI is likely to continue using reverse repo tools to maintain control over short-term rates and ensure smooth policy transmission, especially as inflation pressures remain manageable.

As the RBI balances liquidity and interest rate management, Wednesday’s auction will offer a key signal of how India’s banking system and its policy path, are adjusting to the new surplus environment.