Mumbai: Reserve Bank of India (RBI) on Friday said that it has revised the ceiling on issuance of securities under the market stabilization scheme (MSS) to Rs6 trillion, from the previous limit of Rs30,000 crore for financial year 2016-17.
“After the withdrawal of the legal tender character of the 500 and 1,000 denomination notes with effect from November 9, 2016, there has been a surge in the deposits with the banks. Consequently, there has been a significant increase of liquidity in the banking system which is expected to continue for some time,” the RBI said in a statement on its website.
Separately, the central bank announced the auction of the 28 days the government’s cash management bills for a notified amount of Rs20,000 crore on Friday, using “Multiple Price Auction” method. This is the first installment of securities under MSS, the regulator said. The cash management bills will have the generic character of treasury bills, it added.
On 28 November, economic affairs secretary, Shaktikanta Das, had said that the government had received a proposal from the banking sector regulator for raising the ceiling on MSS bonds.
According to data released by the RBI, banks had received Rs8.45 trillion worth deposits between 10 and 27 November as India’s banking customers wanted to deposit their high denomination notes in their accounts.
MSS bonds, which were introduced during former RBI governor Yaga Venugopal Reddy’s tenure in 2005, are typically issued by the central bank to manage liquidity operations when intervening in the foreign exchange market.
When the RBI buys dollars, it releases rupee liquidity in the system, which can then be mopped up by sale of MSS bonds.
The bills/bonds issued under the MSS would have all the attributes of the existing treasury bills and dated securities. However, unlike regular bonds, these are not issued to meet the government’s expenditure and the funds raised are kept in a separate cash account. As a result, their issuance will have a negligible impact on the fiscal deficit of the government.
On Saturday, the RBI had announced that banks will have to set aside 100% cash reserve ratio (CRR) against deposits they had garnered between 16 September and 11 November, as a temporary measure to control excessive liquidity. The 100% CRR norm is up for review on 9 December.
“This (the MSS announcement) will ensure that CRR move will be rolled back. Even if Rs3 trillion worth paper comes to the market, the government bond yields might harden a little. But they would still be lower than where the yields were before the demonetisation announcement. The last time we saw the MSS issues, most bonds were short term in tenure, so we could expect it this time around too,” said Saugata Bhattacharya, senior vice-president, business and economic research, Axis Bank.
The 10 year bond yield, on Friday, was at 6.23%—little changed from Thursday’s close of 6.22%.
S.K. Ghosh, chief economic adviser and general manager, State Bank of India (SBI), said the RBI would now need to clarify its decision on CRR at the earliest, lest the market start taking the MSS announcement as a double whammy.
Reviewing the CRR measure is also crucial for the profitability of India’s commercial banks. That’s because banks don’t earn any interest on CRR. That means, while they have to pay customers interest on the incremental Rs 3.2 trillion deposits that they have gathered between 16 September and 11 November, they themselves won’t be earning anything on these funds.
Thus, while market participants assume that the RBI will cut its policy rate to support growth after the drag from demonetization, using the CRR to suck excess liquidity would jam the transmission to lending rates.
MSS bonds would be “costly from RBI’s perspective, increasing its limits would need some work, and it may not have been as flexible a tool as an ‘incremental and temporary’ rise in the CRR”, wrote Pranjul Bhandari, chief India economist at HSBC Securities and Capital Markets (India), in a 27 November report.