Why RBI disagrees with market perception on policy normalization?

Source: Business Standard

What is the news?

RBI’s decision to conduct variable reverse repo (VRRR) auctions should not be considered as a reversal of the accommodative policy stance.

Background

• Recently, RBI while announcing the review of the monetary policy, said the central bank has decided to conduct fortnightly VRRR auctions.
• However, RBI Governor categorically stated that “these enhanced VRRR auctions should not be misread as a reversal of the accommodative policy stance”.
• But most market participants interpreted liquidity absorption through the VRRR as an indication that the RBI has started to reverse its ultra-loose monetary policy.

Note: Please go through the basics of Repo and Reverse Repo at this link.

Rationale behind VRRR

Temporary liquidity absorption

The 14-day variable repo/reverse repo auction was categorized as instruments to manage short term or transient liquidity. When the tenor of VRRR is more than 14 days, the objective is to manage durable liquidity.

• Hence, by announcing a 14-day variable repo rate auction, the message was clear from the central bank. They do not want to disturb the durable liquidity; it is the temporary liquidity surplus that they want to absorb. One of the reasons behind this temporary surplus is lack of government spending.

Aligning the overnight rates to the repo rate

One more objective behind announcing this particular measure was also to align the overnight rates to the repo rate. Since the Covid-19 pandemic broke out in March 2020, the overnight rates are actually around the reverse repo rate. This decision to conduct VRRR auction will push up short term rates towards repo rate