Mumbai/New Delhi: The government has received a proposal from the Reserve Bank of India to increase the amount issued under the so-called market stabilization scheme (MSS) bonds, said economic affairs secretary Shaktikanta Das.
After asking banks to set aside all incremental deposits between 16 September and 11 November, the central bank is looking for other ways to drain excess liquidity from the system.
“It is under the consideration of the government,” Das told reporters on Monday.
After the government withdrew Rs500 and Rs1,000 bills earlier this month, banks have seen an avalanche of deposits. By Friday night, they had parked Rs5.25 trillion with the central bank, accepting government securities as collateral. That brings it dangerously close to its Rs7 trillion government bond holding with RBI, forcing the central bank to look at other measures to soak up liquidity such as the increase in the cash reserve ratio (CRR).
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 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 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. The MSS limit for this financial year has been set at Rs 30,000 crore. Any revision to this limit requires the government to seek parliamentary nod.
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.
However, RBI governor Urjit Patel on Sunday told the Press Trust of India that the measure to raise CRR was temporary and would be reviewed once the government issued more MSS bonds.
“If RBI uses MSS to stabilize liquidity, it will have a negative impact on the Government securities market. We would like to emphasize further reactive policy decisions (say, of changes in MSS structure/deposit addition beyond 11 November) will create unnecessary and unwanted market hype and build up adverse market expectations about impending policy announcements,” said Soumya Kanti Ghosh, chief economic adviser at State Bank of India.
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.
Das said that he wouldn’t speculate on the possibilities in the RBI monetary policy, which is due next week. “I am sure RBI will take a considered decision,” he said.