Market Stabilization Scheme (MSS) is a monetary policy tool used by the RBI to manage money supply in the economy.
(You may also read: Repo, CRR, SLR, Reverse Repo, Bank Rate- Explained)
Under Market Stabilization Scheme or MSS, if there is an excess money supply in the economy, RBI intervenes by selling Government securities (like Treasury Bills, Cash Management Bills & Dated securities.). This helps to withdraw the excess liquidity from the system.
How is Market Stabilization Scheme different from Open Market Operations?
Open Market Operations (OMO) is buying and selling of Government securities to manage money supply in the economy. Thus, it is used to both inject and withdraw liquidity. Moreover, these securities are a part of Government borrowing.
MSS is only selling of Government securities to withdraw excess liquidity. The money raised through the selling of securities is kept in a separate account known as MSS account,
The amount kept in the MSS account is only used for redemption of securities issued under the MSS. This money is not used by the Government to meet its expenditure requirement. It is not a part of Government borrowing,
However, interest is paid on the securities issued under MSS. Hence, there is only a marginal impact on fiscal deficit due to interest payments. The cost of interest payment is shown separately in the budget.
(However, following the global financial crisis of 2008, an amendment allowed the Government to convert a portion of the MSS funds into normal government borrowing for financing its stimulus expenditure requirements.)
Why was Market Stabilization Scheme (MSS) introduced?
The Market Stabilization Scheme (MSS) was launched in April 2004.
During 2002-2004, there were huge capital inflows into India. This led to an appreciation of the rupee (because demand for Indian rupee increased). Appreciation of rupee is not good for exports as it makes exports more expensive.
Therefore, RBI had to intervene in the foreign currency market. It started buying US dollars with Indian rupee. (to increase the supply of Indian rupees and devalue the rupee)
But, this increased the liquidity in the economy and had the potential to stoke inflation. To combat this, the RBI sold Government securities to withdraw the excess liquidity. This withdrawal of excess liquidity is also known as sterilisation.
The selling of Government securities depleted the limited stock of securities held by the RBI.
Therefore, MSS came into being following a Memorandum of Understanding (MoU) between the Government of India and the RBI in the year 2004.
As per the MoU, the Government of India has authorised the RBI to issue Government securities up to a specified ceiling.
(Recently. the Government had increased the ceiling on the securities issued under MSS to Rs 6 lakh crores from Rs.0.3 lakh crores to manage excess liquidity after demonetisation.)
The intention of introducing MSS was to differentiate the liquidity absorption of a more enduring nature by way of sterilisation from the day-to-day normal liquidity management operations. .
The bills/bonds issued under MSS are known as Market Stabilisation bonds (MSBs).
The Market Stabilisation bonds are issued by way of auctions to conducted by the Reserve Bank of India. The Reserve Bank decides and notifies the amount, tenure and timing of issuance of such treasury bills and dated securities.
The Market Stabilisation bonds are purchased by financial institutions like banks.