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.
References:
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Additional Information:
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
Related articles:
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.
The LAF became the principal instrument of liquidity management with an asymmetric interest rate corridor (with repo rate as the ceiling and reverse-repo rate as the floor) varying between 100 bps and 300 bps. As an additional instrument, the Market Stabilisation Scheme (MSS)was introduced in April 2004 to aid sterilisation operations as the security holding of the Reserve Bank of Indida was inadequate.
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