Indian central bank's aggressive withdrawal of cash from the banking system this week indicates it is not looking to loosen its grip on liquidity anytime soon, economists said on Tuesday.

The Reserve Bank of India (RBI) conducted an overnight variable rate reverse repo (VRRR) auction for the first time in seven months earlier in the day, and despite a tepid response, it announced a follow-up auction, which was also under-subscribed.

"It is clear that RBI does not want overnight rates to fall towards SDF (standing deposit facility rate), and they are trying to keep overnight rates between repo and MSF (marginal standing facility) rate," A Prasanna, head of research at ICICI Securities Primary Dealership, said.

"The signaling could be that current conditions do not warrant overnight rates to remain below repo rate."

India's banking system liquidity deficit has eased this week to 1.22 trillion rupees (about $14.7 billion), after hitting a record 3.46 trillion rupees last month as credit growth and tax collections outpaced government spending.


The widening deficit had pushed the interbank money rates above the upper end of the monetary policy corridor. RBI's benchmark policy repo rate stands at 6.50%, the MSF rate at 6.75% and the standing deposit facility rate, which is the floor of the corridor, is 6.25%.

The central bank had been infusing liquidity into the banking system in December-January by conducting shorter duration repo auctions.

However, since early February, government spending has prompted the central bank to shift to a withdrawal mode, traders said.

The RBI has resumed VRRRs to prevent the weighted average call rate from falling below the repo rate, IDFC First Bank economist Gaura Sengupta said.

Still, the central bank is not expected to announce fresh measures on liquidity in its policy decision due on Thursday.

"In the current quarter, the central bank needs to use only repos to infuse liquidity, as government spending will be lumpy," I-Sec PD's Prasanna said.

"April policy would be a better time to take a fresh view on liquidity situation for FY25." ($1 = 83.0324 Indian rupees)

(Reporting by Dharamraj Dhutia; Editing by Swati Bhat and Mrigank Dhaniwala)