RBI steps in with cash boost as borrowing costs surge
&imwidth=600&imheight=450&format=webp&quality=medium "RBI steps in with cash boost as borrowing costs surge")
A Reserve Bank of India (RBI) logo is seen inside its headquarters in Mumbai. Photograph: (Reuters)
India's Reserve Bank (RBI) injected ₹500 billion ($5.8 billion) into the banking system via a two-day repo auction to address rising short-term borrowing costs, as the weighted average call rate surged to 5.79%, surpassing the RBI's repo rate of 5.5%.
India’s central bank is stepping in to calm rising short-term borrowing costs. On Wednesday, the Reserve Bank of India (RBI) announced a ₹500 billion ($5.8 billion) liquidity injection into the banking system via a two-day repurchase (repo) auction, after money market rates unexpectedly spiked above the central bank’s policy benchmark.
The move comes after the weighted average call rate, a key interbank borrowing rate that the RBI closely watches, surged to 5.79 per cent, overtaking the RBI’s repo rate of 5.5 per cent. According to Bloomberg, this marks the first time since March that overnight funding costs have breached the RBI’s policy rate, a development that raises fresh questions about liquidity management and monetary transmission. In a statement, the RBI cited “current and evolving liquidity conditions” as the reason for the cash injection.
Why borrowing costs spiked
The sudden rise in borrowing costs is being linked to monthly tax outflows, particularly GST payments, which pulled large sums out of the banking system. At the same time, aggressive participation by banks in the RBI’s variable rate reverse repo (VRRR) operations, where the central bank absorbs excess liquidity appears to have backfired.
“It seems that banks tendered very aggressively at the last variable rate reverse repurchase operation and once the GST outflows hit the system, they were left with a situation they did not envisage,” said Abhishek Upadhyay, economist at ICICI Securities Primary Dealership Ltd., as quoted by Bloomberg. This mismatch between inflows and outflows highlights the challenge of managing liquidity in a fast-digitising economy where funds move 24/7.
What’s behind the volatility?
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While liquidity fluctuations are not new, the RBI is under increasing pressure to stabilise funding rates, especially when they deviate from the policy rate, a critical anchor for borrowing costs across the economy. According to DBS Bank Ltd., nearly ₹2 trillion ($24 billion) is currently locked in a seven-day VRRR with the RBI, draining liquidity from the system.
Surplus liquidity, the excess cash parked by banks with the RBI, dropped to ₹2.2 trillion ($26 billion) as of July 22, down sharply from ₹3.9 trillion just a few days earlier, according to Bloomberg Economics estimates. Bond traders are now seeking greater clarity from the RBI on how much surplus liquidity it considers “ideal” following its recent liquidity-draining actions, Bloomberg News reported, citing sources familiar with the matter.
More auctions ahead, but with caution
The RBI is widely expected to continue with its variable rate reverse repo auctions, albeit with smaller amounts, as the market digests recent volatility. “The RBI will likely continue to offer the VRRR auction, though likely reduce the size,” said Nathan Sribalasundaram, rates strategist at Nomura Holdings Inc. “Banks are likely to be a little more cautious this time around.”
The RBI’s next monetary policy meeting is scheduled for August 6, and money market participants will be watching closely for signs of how the central bank plans to recalibrate its liquidity framework. According to RBI Governor Shaktikanta Das, a detailed report on this new liquidity model is expected by end-July.
For now, the central bank’s latest action serves as a reminder of the delicate balance it must strike keeping short-term funding markets stable without undermining its broader inflation and monetary policy goals.
(With inputs from the agencies)