The Reserve Bank of India announced on Friday that it will conduct a variable rate reverse repo auction for ₹2 trillion ($21.6 billion), marking its first such operation in four months. According to reports from The Hindu BusinessLine and Bloomberg Economics, this decision comes as the banking system's liquidity surplus had risen to a near four-year high of around ₹4.3 trillion as of Thursday. The RBI's move was prompted by overnight rates hovering about 17 basis points below the repo rate, which prompted the central bank to announce the variable rate reverse repo operation. This represents the first liquidity withdrawal move of the year as the central bank seeks to push up overnight borrowing costs to its policy rate.
The liquidity withdrawal announcement immediately impacted bond markets, with India's 10-year benchmark yield rising as much as 4 basis points to 7% following the RBI's announcement. As reported by Bloomberg Economics, the 10-year benchmark yield rose as much as 4 basis points to 7% after the Reserve Bank of India announced plans to withdraw liquidity of up to ₹2 trillion via a seven-day variable rate reverse repo auction. Additionally, overnight index swap rates rose 7-10 basis points from the day's low, reflecting the market's response to the central bank's liquidity absorption strategy.
The RBI's decision contrasted with market expectations for continued liquidity support. According to The Hindu BusinessLine, traders had been hoping for a wider liquidity surplus after recent market volatility. On Wednesday, the RBI had kept interest rates on hold and stated it would continue to ensure sufficient liquidity in the banking system to meet the productive requirements of the economy. The central bank's monetary policy report had signaled that liquidity levels of 0.6% to 1.1% of deposits are desirable to maintain the weighted average call rate at a spread of 5-10 basis points below the policy rate.
Market experts interpreted the RBI's decision as a clear signal of monetary policy intent. As reported by The Hindu BusinessLine, Mataprasad Pandey, vice president at financial advisory firm Arete Capital, noted that the benchmark bond yield touched 7% as this announcement did not go well with the market after RBI's remarks just two days ago. Kanika Pasricha, chief economic adviser at Union Bank of India, explained that the choice of a 7-day, rather than overnight absorption, suggests the RBI views the surplus as more durable than transient. This strategy demonstrates the central bank's commitment to actively absorb surplus liquidity and re-anchor short-term rates closer to the policy rate.
