RBI’s VRRR auctions lift overnight rates above repo

By Admin

23 Jul, 2025

The overnight money market witnessed a notable surge in rates on Tuesday, with both call money and TREPS (Tri-party Repo) rates rising above the Reserve Bank of India’s (RBI) repo rate. This uptick was primarily attributed to the central bank’s Variable Rate Reverse Repo (VRRR) auctions and significant tax outflows, which collectively drained liquidity from the system and pushed borrowing costs higher.

Rising Rates Amid Tight Liquidity

According to market data, the weighted average call rate rose to 5.62% on Tuesday from 5.48% on Monday, while the TREPS rate climbed to 5.69%, up from 5.51%. These overnight borrowing rates now exceed the repo rate of 5.50%, indicating a tightening liquidity environment.

The system liquidity dropped sharply to ₹2.40 lakh crore on Monday from ₹3.04 lakh crore on July 20, and significantly down from ₹4.25 lakh crore recorded on July 4. Dealers noted that the VRRR auctions, which absorbed close to ₹2 lakh crore, alongside tax-related outflows, have strained liquidity temporarily.

A dealer from a state-owned bank observed, “System surplus has decreased due to tax outflows and around ₹2 lakh crore is locked in VRRR, causing some pressure in the market today.” To meet their obligations, banks turned to the call and TREPS markets for funds.

RBI’s Strategy to Align Call Rates

Since late June, the RBI has ramped up its use of VRRR auctions to better align the call money rate with the repo rate, the key policy rate. In a recent interview, RBI Governor Sanjay Malhotra stated that the central bank aims to keep the call rate as close to the repo rate as possible, facilitating smoother monetary transmission.

Previously, the call rate had been trading near the lower end of the Liquidity Adjustment Facility (LAF) due to a persistent surplus in system liquidity and weak credit growth. The current VRRR strategy seems to be moderating that trend.

According to V R C Reddy, Head of Treasury at Karur Vysya Bank, “Banks parked higher amounts at VRRR auction, expecting to manage tax outflows from overnight market at a cheaper rate. When some banks parked their excess fund, others parked more than the excess amount to take the advantage of arbitrage. This pushed rates higher, though system has comfortable liquidity surplus.”

Outlook: Temporary Tightness Expected to Ease

The RBI’s recent seven-day VRRR auction for ₹2 lakh crore saw strong participation, with a total subscription of ₹2.08 lakh crore at a cut-off rate of 5.49%. Market participants suggest that this current pressure in rates is likely temporary, expecting normalization as the existing VRRR matures.

“I expect rates will get adjusted in the next 2-3 days and the average TREPS rate will hover between the Standing Deposit Facility (SDF) rate of 5.25% and the repo rate of 5.50%,” Reddy added.

Although speculation surrounds another potential VRRR auction this week, traders expect the participation to be subdued, given the ongoing recalibration in the money markets.

Meanwhile, Bloomberg reported that Indian bond traders are planning to seek clarity from the RBI on what constitutes a "comfortable" level of liquidity surplus and where the central bank expects overnight rates to settle.

Conclusion

While the spike in overnight money market rates reflects short-term liquidity tightening driven by RBI’s VRRR operations and tax payments, the central bank’s strategy appears focused on enhancing the efficacy of monetary policy transmission. As system liquidity recalibrates, markets anticipate a return to stability in the days ahead, with the call rate settling closer to the policy rate.