SIMPLY PUT: The four letters that forced the Indian markets to sober down

The Nifty and Sensex, the benchmark equity indices that reflect the overall mood in the Indian stock market, had rallied 3% in the last one month. But the excitement sobered down on Friday, August 3, after the speech from the central bank governor, Shaktikanta Das.

The monetary policy panel decided to increase the amount of money absorbed through variable rate reverse repo (VRRR) auctions.

What is VRRR and how does it work?

Since Jan 2021, the Reserve Bank of India (RBI) has been taking out about ₹2 lakh crore from the banking system every two weeks. It has now decided to increase that figure substantially.


While the governor warned that the market should not read the above increase as the pullback in the RBI’s accommodative stance, many in the market had already seen this as the first step towards tightening the liquidity by the regulator.

Sucking out the money in the system affects the demand for assets, including financial assets like shares and bonds. Both the Nifty and the Sensex are down nearly a quarter of a percent after this announcement.

Why is the RBI reducing liquidity?

The Indian economy was stuck between a rock and a hard place for close to 18 months now. The pandemic, and the lockdowns that followed, has hammered national income and the supply constraints have led to a price rise.

Inflation, in theory, is a result of too much cash chasing too few goods and services.

For instance, since the outbreak of the COVID-19 pandemic, people still had to buy the daily essentials like milk, vegetables and eggs. However, because of the lockdowns, the vendors could not get the supply on time. So that pushed the prices up because people were willing to pay the extra amount for a timely supply.

As the lockdowns in different parts of the country lift, and the economy slowly opens up, the supply constraints may ease and there may be no need for the excess cash in the system.

RBI’s inflation forecast for the rest of the financial year has been raised to 5.7% from its earlier estimate of 5.1%. “At this juncture, our overarching priority is that growth impulses are nurtured to ensure a durable recovery along a sustainable growth path with stability,” Governor Shaktikanta Das said in his concluding remarks.

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