The Reserve Bank of India (RBI) seems to be caught in a Catch-22 situation. On one hand, it cannot let the rupee slide endlessly; on the other, it has to ensure that there is enough liquidity in the banking system.

Consequently, it is fighting on both fronts — defending the rupee by selling as much as $12 billion in the last three days while the size of the variable rate repo (VRR) auctions is also increasing to record levels.  

On Wednesday, it announced two steps to infuse liquidity — a 49-day VRR auction worth Rs 75,000 crore on February 14 and another VRR auction worth Rs 2.75 lakh crore on Thursday, the highest auction size since the apex bank started conducting such auctions daily since January 16. On Wednesday, it had conducted VRR auction of Rs 2.5 lakh crore. It received bids of Rs 1.98 lakh crore.

“This is the best strategy that can be followed at this time because of twin problems of rupee depreciation and liquidity deficit. As long as we have uncertainties in the forex market, there will be continuous pressure on the RBI to do something about the rupee. Through VRRs, the RBI is infusing liquidity, which is being sucked out due to forex interventions to defend the rupee,” said Madan Sabnavis, chief economist, Bank of Baroda. “The 49-day VRR indicates the assessment by the RBI that the liquidity conditions are going to remain tight till end of March.”  

Despite multiple measures by the central bank, liquidity conditions remain tight, with the shortfall hovering around Rs 2 lakh crore. As per RBI data, the banking system’s liquidity deficit stood at Rs 1.96 lakh crore on Tuesday.

“Liquidity continued to remain in the deficit zone, but the tightness eased, driven by CRR drawdown, RBI’s forex swap auction and net government spending, more than compensating for excise/customs-related tax outflows,” said Kotak Institutional Equities. “While in February, we estimate core liquidity to remain near neutral to marginally in surplus, we estimate the core liquidity to again turn deficit from March, warranting more measures by the RBI then.”

The RBI last month announced a series of measures to ease tight liquidity conditions. The measures include carrying out open market operations (OMO) purchase auctions, conducting VRR and dollar-rupee buy/sell swap auctions. The apex bank commenced daily VRR auctions on January 16 with an initial size of Rs 50,000 crore. Subsequently, the size has gradually been increased to address prevailing liquidity tightness.

“To compensate for a drain on durable liquidity due to heavy forex intervention, the central bank doubled the size of its bond purchases to Rs 40,000 crore via open market operations, compared to earlier notified Rs 20,000 crore. This comes on top of Rs 2 lakh crore via overnight VRR auction on Tuesday,” said Radhika Rao, senior economist, DBS Bank.

While no fresh measures on liquidity were announced at last week’s rate review, this week’s action reinforces that the central bank will tweak its response mechanism in tune with evolving conditions, especially in a bid to sterilise intervention moves, added Rao.

RBI governor Sanjay Malhotra said after the monetary policy meeting on Friday that the apex bank was committed to provide sufficient liquidity in the economy and would take steps to ensure durable liquidity to meet the requirement of the system.

“The liquidity tightness is likely to persist in the coming weeks due to goods and services tax payments and ongoing intervention by the RBI to curb the volatility in rupee. We may see more steps from the RBI to infuse liquidity,” said the head of treasury of a private bank.