As bond traders pore over the Indian central bank’s every action after a recent rise in yields, policymakers are being forced to use their liquidity tools more cautiously to avoid triggering outsized market reactions, sources and traders said.

The Reserve Bank of India, having repeatedly assured markets and the banking sector of comfortable liquidity conditions, has maintained an average cash surplus of over 2.5 trillion rupees ($27.07 billion) or 1 per cent of deposits since February.

It has avoided withdrawing liquidity via short-term variable rate reverse repos (VRRR) – its preferred choice to manage temporary liquidity imbalances – even when overnight rates dropped below the policy rate.

The weighted average call rate (WACR) has stayed around 5.07 per cent , since the start of February, even while the policy repo rate remains at 5.25 per cent. 

Although the central bank has made it clear that VRRRs are a tool intended to manage short-term imbalances, the market still gets spooked when RBI announces one, a person familiar with the central bank’s thinking said, declining to be identified as he is not authorised to speak to media.

“A VRRR does not signal a turn in liquidity thinking,” this person said.

The RBI last used the VRRR tool in December and traders expect no such auctions till the end of March, when India’s fiscal year ends.

“At the moment perhaps (the) market is over-reading VRRR, If the RBI does not do a series of VRRRs, but only occasional ones to keep WACR in the policy band, it should be a signal enough that the RBI is not looking to tighten yet,” said Dhiraj Nim, an economist at ANZ.

Surplus liquidity aids banks raise funds at a cheaper rate.

FBIL benchmark three-month rate for certificates of deposit stood at 7.17 per cent , at a spread of nearly 200 bps over treasury bills.

By maintaining surplus liquidity, the central bank is removing the frictional stress that arises at systemic level and is allowing institutions like mutual funds to buy bank CDs at better margins, said Alok Singh, head of treasury at CSB Bank.

An email sent to the central bank remained unanswered.

FRICTIONAL VS DURABLE LIQUIDITY

The RBI last reviewed its liquidity framework in 2025, when it reiterated its stance that the WACR remains the operative target of monetary policy.

This means the central bank attempts to maintain liquidity at a level where the call rate remains close to the policy rate.

A 10-15 basis point gap between the call rate and the policy rate is acceptable, a second source, also familiar with the central bank’s thinking said.

The liquidity review also stated that variable rate repo and reverse repos will be the primary tools to adjust temporary or frictional liquidity imbalances.

For more longer term liquidity absorption or infusion, the central bank typically uses bond sales or purchases and, more recently, longer term forex swaps.

“Given the lack of clear communication and consistency around VRRR operations, markets tend to read them as an attempt by the central bank to tighten liquidity,” a treasury head at a private sector bank said.