Consider the following statements regarding the Variable Rate Repo (VRR):
1. It is mainly used to inject liquidity during short-term liquidity crunches on a fortnight basis.
2. It is adjusted by the Reserve Bank of India like the Repo Rate.
3. It can fall below the Reverse Repo Rate in certain cases.
How many of the above statements are correct?
(a) Only one
(b) Only two
(c) All three
(d) None
Explanation Context: Recently, the Reserve Bank of India (RBI) has announced that it will conduct daily variable rate repo (VRR) auctions on all working days in Mumbai, until further notice.
Statement 1 is correct: Variable Rate Repo is a market-determined mechanism to meet transient (short-term) liquidity shortages and offset mismatches. Similarly, Variable Reverse Repo Rate is used to absorb excess liquidity. It is used for longer durations, usually ranging from 2 to 14 days, i.e. fortnight.
Statement 2 is not correct: VRR is a market-determined rate that is decided through competitive bidding based on demand and supply responding to market conditions. When banks are reluctant to borrow at repo, the RBI lets the rate be decided by the lower market interest rates. Hence, it is always less than the Repo rate, which is determined by the RBI.
Statement 3 is not correct: It can never fall below the Reverse Repo Rate, at which the RBI borrows money from the market (banks), because if the RBI increases the reverse repo rate, banks may be less willing to lend to each other, leading to a rise in market interest rates, which influences the VRR.
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