The seven-day variable rate repo (VRR) auction, held by the Reserve Bank of India (RBI) on Friday, witnessed a robust response, as banks submitted bids totalling Rs 4.25 trillion, which is approximately 2.5 times the notified amount of Rs 1.75 trillion.

High bids from desperate banks show the extent of cash squeeze in the system. The liquidity deficit in the banking system widened to near 8-year-high of Rs 2.58 trillion on Thursday, prompting the central bank to conduct the second VRR in December.

Sabnavis expects the central bank to conduct another VRR auction next week as liquidity is expected to remain tight. The liquidity remains tight primarily on account outflows towards advance tax payments and the GST.

Aiming to ease the liquidity squeeze, the RBI had earlier conducted a seven-day variable rate repo auction on December 15 for Rs 1 trillion, for which the central bank had received bids worth Rs 2.73 trillion.Through RBI’s MSF, banks can obtain liquidity overnight when interbank liquidity dries up.

A repo auction is conducted to inject liquidity in the banking system while the reverse repo auction is conducted to absorb excess liquidity.

The tight liquidity conditions have pushed up overnight money market rates, with the weighted average rate of the inter-bank call money reaching 6.80% on Thursday.

Experts expect tight liquidity conditions to persist in December, and any improvement can be expected from January when the government spending is likely to pick up.

“The market will now be keeping a close watch on the quantum of next VRR auction because the size of auction will signal the trend in liquidity. A lower VRR auction size will mean that the RBI expects some easing in liquidity,” said the head of treasury of a private bank. The credit demand is still outpacing the deposit growth and banks have been reluctant to raise deposit rates as they expect interest rates to moderate from the first half of next year.