Discuss the role of Variable Rate Reverse Repo (VRRR) auctions in RBI's liquidity management framework. How does surplus liquidity affect monetary policy transmission?

Under the Liquidity Adjustment Facility (LAF), the RBI injects or absorbs funds so that the overnight call rate stays aligned with the policy repo rate [1]. The VRRR — an auction-based absorption tool — has become the frontline instrument in a phase of record surplus liquidity, as seen on 22 September 2026 when ₹71,971 crore was mopped up [2].

Role of VRRR in the liquidity framework

• Sterilisation of surplus: against ₹75,000 crore notified, ₹71,971 crore was absorbed at a 5.24% cut-off with 96% bid coverage, withdrawing excess funds without touching the repo rate [2].
• Market-discovered pricing: unlike the fixed-rate overnight reverse repo, the rate emerges from bids, revealing banks' true opportunity cost and pulling call-market rates upward [1].
• Tenor flexibility: operations run from overnight to 14 days; the RBI's Internal Working Group has recommended making 7-day and shorter operations the main tool, discontinuing 14-day VRR/VRRR, with at least one day's advance notice to the market [3].
• Operational, not policy: VRRR is RBI's day-to-day tool; the repo rate remains the MPC's domain [1].
• Limits: an overnight absorption reverses next morning, so a durable surplus — driven by the June–August 2026 FCNR(B)/ECB swap facility inflows — also needs OMOs and forex swaps [3][4].

Surplus liquidity and transmission

• Excess funds push the weighted average call rate towards or below the repo rate, making the effective policy rate softer than the announced one and blurring the corridor's signal [3].
• It dilutes rate signalling in a tightening phase, since banks flush with funds need not chase deposits or reprice loans.
• Unabsorbed liquidity carries inflationary risk and can misdirect credit.
• Conversely, moderate surplus speeds transmission to deposit and lending rates during easing — the problem is the uncontrolled overhang, not liquidity itself.

VRRR thus keeps the operating target anchored while the MPC's stance does the signalling. Combining calibrated short-tenor auctions with durable instruments, predictable communication, and a deepened call money market would make transmission both faster and more credible — reinforcing the inflation-targeting mandate under the RBI Act.