Market Stabilization Scheme (MSS) is a monetary policy tool used by the RBI to manage money supply in the economy.
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 the redemption (repayment) 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 a marginal impact on fiscal deficit due to interest payments. But, there is no impact on fiscal deficit due to borrowings under MSS as it not used to meet 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 the Indian rupee increased). Appreciation of the 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 the 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. The RBI ran out of stock of regular Government securities.
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.
Banks were flush with excessive liquidity after demonetisation. The RBI initially asked banks to deposit the excess deposit as cash reserve ratio (CRR). Later, it decided to use MSS. This is because the banks earned no interest on money set aside as CRR. In addition, MSS bonds qualifies as Statutory Liquidity Ratio/ SLR as well.
(You may also read: Repo, CRR, SLR, Reverse Repo, Bank Rate- Explained)]
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 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 tenure of such bonds are mostly less than 6 months.
The Market Stabilisation bonds are purchased by financial institutions like banks.
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