In another move to ease the pressure of huge capital inflows and on a day the rupee touched a near-decade high, the government on Wednesday strengthened the apexbank’s hand to intervene in the currency market.
A statement from the Reserve Bank of India (RBI) after market hours, said the ceiling on bonds or the Market Stabilization Scheme (MSS) it uses to suck cash from the banking system had been lifted by a quarter to Rs2.5 trillion ($63.6 billion) for the fiscal year 2007/08.
The threshold at which the limit will be reviewed is Rs2.35 trillion. With the auction of the MSS bonds held on Wednesday, the outstanding of the MSS will be Rs1.8 trllion as on 8 November, the release further said.
In order to rein in the value of the rupee, the apex bank has had to intervene in the currency market. The currency has risen about 15% since the beginning of the calendar year and RBI has bought close to $40 billion over the first eight months this year.
For every dollar RBI buys, an equivalent amount in rupees is released into the system. MSS bonds are issued to soak out this rupee liquidity from the system.
These bonds are outside the government of India’s annual borrowing programme, and are auctioned to bridge the government’s fiscal deficit.
The MSS bond ceiling has been raised three times in 2007, the latest being in October. In the case of MSS bonds, the government bears the cost of draining the excess liquidity from the market.
There are two other ways of sucking of excess liquidity from the system. RBI soaks daily liquidity through its reverse repo window at a cost of 6%. The other way is to increase the minimum cash reserve that banks have to maintain with RBI. In banking parlance this is known as the cash reserve ratio (CRR). RBI in its mid-year review of the monetary policy, raised the CRR by 50 basis points to 7.5%.