Primer on Market Stabilisation Scheme
and Liquidity Management
After a gap of six to seven years, MSS has become a buzzword in the financial space once again. Government of India today, based on the recommendation of the Reserve Bank of India, raised the MSS ceiling for financial year 2016-17 to Rs 600,000 crore from Rs 30,000 crore fixed earlier. The steep increase in MSS ceiling is necessary as banks have been receiving large amount of deposits following the currency ban on Rs 500 and Rs 1,000 bank notes with effect from November 9th.
So what is MSS? Simply put, MSS is an acronym for market stabilisation scheme. MSS is used by country's central bank RBI as a monetary policy instrument for liquidity absorption and/or injection. RBI already uses other tools like LAF Repo, Reverse Repo and CRR. Why doesn't RBI use these tools instead of MSS? What is the impact of MSS on fiscal deficit? I will try to answer them in this write-up.
1. What is MSS?
The Market Stabilisation Scheme (MSS) in an innovative sterilisation tool introduced by the RBI in 2004. It basically deals with the liquidity impact of surging capital flows, such as foreign direct investment (FDI) and foreign portfolio flows (FPI).
The MSS is an instrument for active liquidity and monetary management, in addition to other tools such as LAF repo rate, reverse repo rate and bank rate. It has enabled RBI to conduct exchange and monetary management operations in a flexible and stable manner.
2. Why did the Government increase the MSS ceiling steeply and suddenly?
The Government of India today raised the MSS ceiling to Rs 600,000 crore for the financial year 2016-17 from Rs 30,000 crore fixed earlier. The steep raise was expected for the past one or two weeks following the flood of money into bank deposits due to the currency ban on 8 November 2016.
This MSS instrument was used by RBI between 2004 and 2010 to first absorb liquidity of FII (now FPI) inflows into Indian securities and later inject liquidity into the financial system post the global financial crisis (GFC) that started in 2008. After the Lehman Brothers crisis, RBI started unwinding/de-sequestering of the MSS securities and released liquidity into the banking system, without expanding its balance sheet. The MSS outstanding balance has remained zero since 28 July 2010 till yesterday.
3. Will the Government use MSS money absorbed by RBI?
Issue of MSS bills/bonds by RBI leads to accretion of government deposits with the RBI, but they remain sterilised in the sense the government cannot use these MSS funds for its expenditure purposes. Amount raised under MSS will be kept in MSS cash account, which is separate from the normal cash account of the Central Government maintained with the RBI. Basically, RBI impounds these MSS funds.
4. What is the impact of issue of MSS securities on country's fiscal deficit?
The Market Stabilisation Scheme is backed by a corresponding equivalent amount of cash balances with the RBI. Amounts raised from MSS bills/bonds will not enter the Consolidated Fund of the Central Government.
As the funds raised under MSS would remain hoarded by the RBI in its books, there is no impact on the fiscal deficit of the Centre.
After MSS unwinding/de-sequestering, the money will be transferred from MSS cash account to the normal cash account of the Government. With the unwinding of MSS bills/bonds, the government will be able to use the money for its expenditure.
Interest due on MSS securities will be paid by the Central Government--to this extent MSS will impact the fiscal deficit of the government.
5. What type of instruments are issued under MSS?
Under the MSS, RBI issues dated securities and Treasury bills by way of auctions--either multiple price auction or uniform price auction up to a limit mutually agreed upon between the Government and RBI. They are marketable government securities eligible for statutory liquidity ratio (SLR), repo and LAF.
Today, the RBI issued 28-day cash management bills (CMBs) worth Rs 20,000 crore under the MSS, after raising the MSS ceiling for FY 2016-17 to Rs 600,000 crore.
6. What is the difference between LAF and MSS?
The Liquidity Adjustment Facility (LAF) is basically used for day-to-day liquidity management, while the MSS is used for semi-durable and durable mismatches.
The LAF is used for short-term liquidity purposes, whereas the MSS is used for funds of medium or long term nature. For greater transparency and stability in the financial markets, the RBI releases an indicative quarterly schedule for issuance of Treasury bills and dated securities.
7. Who will invest in MSS bills/bonds?
The participants in the auction of MSS bills/bonds are commercial banks, cooperative banks, financial institutions such as insurance companies, primary dealers, etc.
8. What other types of policy tools are used by RBI in its liquidity management?
LAF: The Liquidity Adjustment Facility (LAF) introduced in June 2000 is the primary tool used by the RBI for liquidity absorption (reverse repo) and injection (repo) for day-to-day purposes. It is generally used for temporary purposes, not for liquidity of enduring nature. The LAF enables the RBI to modulate short-term liquidity ensuring overnight call money rates move in the LAF corridor (between repo and reverse repo rates). The LAF repo rate has emerged as the policy signalling rate.
OMO: With open market operations, RBI purchases and sells government securities. It is the main instrument of sterilisation used by the RBI. OMO sales entail the permanent absorption of the liquidity.
Centre's surplus balance with RBI: The Central Government's surplus balance kept with the RBI also work as an instrument of sterilisation. As the RBI Act does not permit RBI to pay interest on such balances, these balances are invested in government securities held with the RBI.
CRR: Cash reserve ratio (CRR) is considered a blunt instrument for impounding liquidity of the banking system. Currently, CRR is kept at 4%. On 26 November 2016, RBI imposed an incremental CRR of 100% on increase in bank balances between 16 September 2016 and 11 November 2016. This additional CRR is a temporary step to manage excess liquidity arising from currency ban.
MSF: Marginal standing facility was introduced by the RBI in 2011. The MSF is an additional window provided by RBI to banks, so that the latter can borrow overnight funds from the RBI against their excess SLR (statutory liquidity ratio) holdings. MSF scheme is similar to the LAF-Repo scheme. The difference between MSF and LAF-Repo is that under MSF, banks will have to pay higher rate of interest to RBI for their borrowings as compared to LAF-Repo.
In addition to the above (MSS, LAF, OMO, Centre's surplus balance, CRR and MSF), RBI also uses SLR and bank rate as monetary policy tools.
Earlier, RBI used policy tools such as, prescribing deposit and lending rates of commercial banks, selective credit control (SCC) over sensitive commodities and sector-specific standing facilities. But over the years, it had stopped using them.
9. Who will bear these costs of sterilisation?
a) In case of cash reserve ratio (CRR) and incremental CRR, banks bear the costs as RBI doesn't pay any interest on such CRR balances.
b) Government of India bears the cost of interest in the case of MSS.
c) In case of LAF window, RBI bears the costs.
So the costs are shared among all the three players. Of course, the costs borne by RBI will reflect in its balance sheet by way of lower transfer of surplus to the government.
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What are the indicators of liquidity in the Indian financial system?
a) Outstanding balances under LAF (repo and reverse repo) on a specific date
b) Outstanding balances under MSS on a specific date
c) Central government's surplus with the RBI on a specific date
Disclosure: The author has a vested interest in the financial markets.
Disclaimer: The author is a CFA Charterholder (USA) and an investment professional. The views are personal. His views should not be construed as investment advice. Before making any investments, you are advised to consult your registered financial advisor. The author will in no way responsible for the decisions taken by readers.