What is Market Stabilization Scheme (MSS)? How it is used to manage demonetisation?

Market Stabilization scheme (MSS) is a monetary policy intervention by the RBI to withdraw excess liquidity (or money supply) by selling government securities in the economy. The MSS was introduced in April 2004. Main thing about MSS is that it is used to withdraw excess liquidity or money from the system by selling government bonds.

Origin of MSS

Initially, the MSS was launched to withdraw the excess liquidity in the system that was generated as a result of the RBI’s purchase of foreign currencies in the foreign exchange market. From 2002 onwards, there was huge inflow of foreign capital into India. This led to appreciation of rupee. Since appreciation is not good for exports, the RBI intervened in the foreign exchange market by buying dollars. To buy dollars, the RBI has to give rupees. In this way, high selling of rupees leads to excess liquidity (rupee) and thereby creating a potential for inflation. To overcome this situation, the RBI has sold government bonds on a general basis depending upon the volume of excess liquidity in the system. Here bonds go to financial institutions and money goes back to the RBI. This withdrawal of excess liquidity is called sterilisation.

During 2007-08, RBI sold Rs 2.5 lakh worth of securities in the financial system implying that Rs 2.5 lakh crore money supply sterilised. Following facts are important to understand MSS.

When MSS is to be used?

MSS is used when there is high liquidity in the system.

What securities to be sold under MSS?

The issued securities are government bonds and they are called as Market Stabilisation Bonds (MSBs). Thus, the bonds issued under MSS are called MSBs. These securities are owned by the government though they are issued by the RBI. It is to be remembered that government is the owner of the securities. Usually, government’s securities (bonds/treasury bills) are sold or issued by the RBI as the central bank is the banker to the government.

What is the peculiarity of the MSBs under MSS?

To carry out the MSS, the government lends its bonds or securities (MSBs) to the RBI. In this way, the RBI becomes a debtor to the government equal to the value of the MSBs.

Whether the government can use the money obtained from MSS?

The money obtained under MSS should be kept with the RBI. It should not be transferred to the government. This is because, if it is transferred, government will spend the money in the economy thereby adding to liquidity.

What is the agreement between the Government and the RBI regarding the MSS?

For the issue of MSS, there is a MoU between the government and the RBI about the total limit of MSBs to be issued by the RBI during a year. As per the latest policy, to manage liquidity in the background of demonetisation, the government has increased the limit of MSBs to 6 lakh crores.

Who purchases the MSBs?

The securities or bonds/t-bills issued under MSS are purchased by financial institutions. They will get an interest for purchasing the securities.

How interest payments for MSBs are met?

The money procured from selling bonds under MSS are kept with the RBI. At the same time, interest payments have to be given to the institutions who buys bond. Here, for the interest payment, the government allocates money from its budget to the RBI. This expenditure to service interest payment for MSBs is called carrying cost.

What is the current policy on MSS in the context of demonetisation?

As per the latest policy, the government has increased the amount of MSBs to be issued to Rs 6 lakh crores from just 0.3 lakh crores in the context of demonetisation.

Why the MSS is needed to manage the demonetised situation?

After demonetisation, huge deposits were put into the banking system. At the same time, banks can’t lend it to customers as it is just temporary money. The RBI has instructed banks to keep all the additional deposits as CRR. But here, the banks will suffer losses as they have to pay interest to the depositors.

To compensate banks, the MSS policy is revived. Here, banks can put the excess money obtained from deposits in MSBs. They can get an interest payment as well.