The Reserve Bank of India (RBI) on December 20 announced a three-day variable rate reverse repo (VRRR) in a surprising move. The central bank was intending to close in on Rs 2 lakh crore in absorptions, but the auction, which happened the same day as the announcement, saw only Rs 81,160 crore being offered by the banking system.

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The sudden announcement of the VRRR is being seen by market leaders as a sign of the RBI’s intention to tighten inflation by hiking interest rates in the near future.

RBI Governor Shaktikanta Das had previously announced that the central bank would be increasing the amount it absorbs from VRRRs with two scheduled auctions on December 17 and December 31, with Rs 6.5 lakh crore and Rs 7.5 lakh crore being absorbed. The auctions on December 20 and 21 were not part of the scheduled ones. Das had also added that the central bank would be increasing its liquidity absorption mainly through the auction route going forward from January 2022.

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"Today's action by the RBI shows that contrary to its words, the persistence of inflation has definitely caused discomfort at Mint Street. The intent is clearly to suck out liquidity but it has caused unnecessary volatility in the market, particularly in the short end, which could have been avoided," said Naveen Singh, Head, Fixed Income, at ICICI Securities Primary Dealership.

"The system does not have as much excess liquidity as it had a few months ago. Banks who had more cash had kept it for disbursals at the quarter-end. The RBI move has impacted all calculations. But one thing is clear, rates are now set to increase," said Sanjaya Wasan, Head of Treasury at Punjab National Bank.

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While the RBI targets inflation of 4 percent with a 2 percent tolerance band on either side, the rise of core inflation rate (inflation rate excluding food and fuel) to a five-month high of 6.08 percent last month may have been the impetus needed for RBI to start aggressively tackling excessive liquidity in the economy.

(Edited by : Shoma Bhattacharjee)