Context: The Reserve Bank of India (RBI) doubled down on its liquidity injection measures for the banking system by announcing measures such as a $5 billion USD/INR buy/Sell swap auction of six months tenor and open market operation (OMO) purchase auctions of G-Secs aggregating ₹60,000 crore.
Relevance of the Topic:Prelims: Important terms related to Banking System
RBI’s Liquidity Injection Measures
- Rationale: Banking system in India is facing a high liquidity deficit, prompting RBI to undertake actions to inject liquidity into the system.
- Liquidity deficit has arisen due to tax outflows and limited government spending.
- The liquidity deficit is estimated at about ₹3 lakh crore.
- Measures announced: VRR Auction, USD/INR Buy/Sell Swap, OMO Purchase of G-Secs.
- VRR Auction: A 56-day variable rate repo (VRR) auction for a notified amount of ₹50,000 crore.
- This will probably be the first time that a VRR auction for such a long tenor will be conducted.
- Possible Impacts:
- Liquidity infusion of about ₹1.50 lakh crore for the banking system in a phased manner
- Softening effect on the yields of Government securities (G-Secs).
- USD/INR Buy/Sell Swap auction of $5 billion for a tenor of six months to be held on January 31, 2025.
- OMO purchase auctions of G-Secs for an aggregate amount of ₹60,000 crore in three tranches of ₹20,000 crore each.
What is Liquidity in the Banking System?
- Liquidity in the banking system refers to readily available cash that banks need to meet short-term business and financial needs.
- Liquidity Deficit: On a given day, if the banking system is a net borrower from the RBI under Liquidity Adjustment Facility (LAF), the system liquidity can be said to be in deficit.
- LAF refers to the RBI’s operations through which it injects or absorbs liquidity into or from the banking system.
- Liquidity Surplus: If the banking system is a net lender to the RBI on a given day, the system liquidity can be said to be in surplus.
What are Open Market Operations?
- Open Market Operations (OMOs) are market operations conducted by RBI by way of sale/purchase of government securities to/from the market with an objective to adjust the rupee liquidity conditions in the market.
- If there is excess liquidity, RBI resorts to sale of securities and sucks out the rupee liquidity.
- Similarly, when the liquidity conditions are tight, RBI buys securities from the market, thereby releasing liquidity into the market.
What is Forex Swap?
| Criteria | Forex Sell/Buy Swap | Forex Buy/Sell Swap |
| What does the RBI do? | RBI Sells dollars with an agreement to buy back same amount of dollars at future date and at fixed exchange rate | RBI Buys dollars with an agreement to sell amount of dollars at future date and at fixed exchange rate |
| When is it adopted? | Shortage of dollars -> Rupee Depreciation.Hence, RBI sells dollars and sucks out Rupee to control Rupee Depreciation | Surplus of dollars -> Rupee Appreciation.Hence, RBI buys dollars and injects Rupee to control Rupee Appreciation. |
| What does it lead to? | Rupee Revaluation: Increase in value of Rupee due to RBI’s Intervention | Rupee Devaluation: Decrease in value of Rupee due to RBI’s Intervention |
| Impact on Rupee Liquidity | Decreases | Increases |
| Impact on Forex Reserves | RBI sells dollars -> Decline in Forex Reserves | RBI Purchases dollars -> Increase in Forex Reserves |
What is Variable Rate Repo (VRR)?
- VRR is a mechanism where the RBI permits banks to borrow funds at rates determined by the market.
- This differs from the fixed Repo Rate at which banks borrow directly from the RBI.
- VRR typically lasts up to 14 days.
- It serves as a means to inject short-term liquidity into the banking system.
What is Variable Rate Reverse Repo (VRRR)?
- VRRR is used to absorb surplus liquidity from the system.
- It is used by the RBI to effectively manage liquidity and influence short-term interest rates in the Indian banking system.
- VRRR represents the interest rate at which the RBI borrows funds from commercial banks for varying durations, typically in the slots of 7, 14 and 28 days.