5 things you must know about RBI's Market Stabilisation Scheme

Moneycontrol BureauOn Saturday, the Reserve Bank of India ordered banks to deposit with the regulator their excess cash haul following the demonetisation move. This was no normal dictat. There was a catch -- the banking regulator told banks to hand over all incremental deposits collected between September 16 and November 11. Banks will have to deposit their haul with the RBI from the fortnight beginning November 26 as Banks have to park these deposits with the RBI from the fortnight beginning November 26 as incremental cash reserve ratio (CRR).

The Reserve Bank under Governor YV Reddy initiated the MSS scheme in 2004. To control the surge of US dollars in the Indian market, RBI started buying US dollars while pumping in rupee. This eventually led to over-supply of the domestic currency raising inflationary expectations. MSS was introduced to mop up this excess liquidity.    In the context of demonetisation, why are banks for MSS more than Cash Reserve Ratio (CRR)?

CRR is a percentage of total deposits the banks are required to set aside with the RBI. It is a sort of contingency fund and does not earn any interest. An increase in CRR means the funds available with banks for lending purposes will be that much lower, ultimately limiting the possibility of a lending rate cut by banks. MSS bonds, on the other hand, have a fixed tenure and earn returns. What was the current limit under MSS?

For the current fiscal, the RBI had fixed the ceiling under MSS at Rs 30,000 crore. However, a higher amount will be required now to contain liquidity post demonetisation.What are some other tools to suck out liquidity?

Apart from issuing MSS bonds and increasing CRR, the Reserve Bank can resort to tools like reverse repo, or interest yielding short term cash management bills that can help drain additional liquidity.