Story Of The Week

MSS: REMOVING THE EXCESS FROM THE MESS

After the demonetization move by the government and withdrawal of the legal tender character of Rs 500 and 1000 denomination notes, there has been a surge in bank deposits. Consequently, this has led to a significant increase of liquidity in the banking system.

Following this, the RBI has directed the banks to deposit their excess cash with the regulator. The banking regulator has told banks to hand over all incremental deposits collected between September 16 and November 11 to RBI from the fortnight beginning November 26 as incremental Cash Reserve Ratio(CRR).

But the CRR impacts the banks’ balance sheets and the financial system. There are other schemes as well to drain this liquidity and the forerunner from all of them is the Market Stabilization Scheme.

What is MSS?

MSS or Market Stabilization Scheme, is a tool utilized by Reserve Bank of India to drain excess liquidity from the system. It is done by issuing securities such as Treasury Bills, Dated Securities, Cash Management Bills (CMBs) etc. on behalf of the government. However, the money raised is not utilized to fund the government’s expenditure or is neither deposited in the government’s account. It is kept in a separate account called the MSS account.

What lead to the launch of MSS?

The MSS scheme was started in 2004 under the former governor, YV Reddy. It was launched to strengthen the RBI’s ability to facilitate monetary management and to manage liquidity operations when intervening in the foreign exchange market. To control the surge of US dollars in the Indian market, RBI started buying US dollars while pumping in the Rupees. Subsequently, this led to over-supply of the domestic currency, raising inflationary expectations. MSS was introduced to absorb this excess liquidity.

What is the need to launch MSS in 2016?

After November 8th 2016, following the demonetization scheme the government withdrew Rs 500 and Rs 1,000 bills from the economy. According to the latest RBI data, banks have garnered Rs 8.11 lakh crores of deposits between November 10th and November 27th  as people rushed to bank to shun their old Rs 500 and Rs 1,000 currency notes, which become invalid tenders from November 9th .
On the other hand, RBI has disbursed Rs. 2.17 lakh crores either over the counter or through ATMs, leaving about Rs. 6 lakh crores with themselves. The RBI expects more deposits to pour in as the government has allowed deposits of old high-value currencies.

This excess of liquidity has made bond yields fall sharply and has lead banks like SBI to slash deposit rates by as much as 190 basis points to protect profitability.

According to Dipak Gupta, Joint Managing Director, Kotak Mahindra Bank “The RBI’s decision to introduce MSS will prevent deposit rates from coming down irrationally, and will also address the short-term surge in liquidity.”

Hence, the MSS has been introduced and has increased by 20 times to ensure that the banking system goes back to its pre-November 8th status.

Features of MSS

  1. The Government issues treasury bills and dated securities in addition to its normal borrowing requirements. They have all the attributes of existing treasury bills and dated securities.
  2. MSS is issued by way of auctions to be conducted by the RBI. The Government, in consultation with the RBI, will fix an annual aggregate ceiling for these instruments. For 2004-05, the ceiling was Rs. 30,000 crores. On 2nd December 2016, the government raised this ceiling to Rs. 6 lakh crores, owing to demonetization.
  3. The amounts which are credited into the MSS account are appropriated only for redemption and/ or for buyback of the treasury bills and / or dated securities issued under the account.
  4. The payments for interest and discount are not made from the MSS account. Similarly, the receipts due to premium and / or accrued interest are not credited to the MSS account.
  5. The treasury bills and dated securities issued are matched by an equivalent cash balance held by the Government with the RBI. Thus, there is only a marginal impact on revenue and fiscal balances of the Government to the extent of interest payment on treasury bills and/ or dated securities outstanding under the MSS.

Why are Banks more favorable towards MSS than CRR?

CRR or Cash Reserve Ratio is the percentage of total deposits that the banks are required to set aside with the RBI. It is a fund which does not earn interest. If CRR increases, the funds available with banks for lending purposes decrease which limits the possibility of cutting lending rate by banks. However, MSS bonds bear returns and have a fixed tenure.

MSS Bonds from RBI’s perspective

According to Pranjul Bhandari, The Chief India Economist at HSBC Securities and Capital Markets, MSS bonds would be costly from RBI’s perspective and it is not as flexible a tool as CRR is. Moreover, the issue of MSS might create a negative impact on the Government securities market. In the words of Ms. Soumya Kanti Ghosh, Chief Economic Adviser at State Bank of India, “MSS will create unnecessary and unwanted market hype and build up adverse market expectations about impending policy announcements”.

Recent development in MSS:

Recently, the Reserve Bank of India has increased MSS deposit ceiling to Rs 6 lakhs Crore and auctioned cash management bills for an amount of Rs 20,000 Crore with a tenure of 28 days, which attracted 47 bids in all for notes worth Rs 40,765 Crore.

The cut-off price for the auction was Rs 99.53 and at this price, the instruments carried an indicative yield of 6.1557%. The weighted average price came in at Rs 99.54.

Future of MSS

 Currently, the hike of MSS is valid only for 28 days and these bonds will most likely be sold by 9th December. MSS is a move to drain excess liquidity from the system which will increase government’s debt. As the cash availability with banks will reduce, this could lead to an increase in the interest rate which could further have a negative impact on inflation.

 References:

http://www.financialexpress.com/opinion/demonetisation-for-banks-agony-of-surplus-liquidity-higher-than-ecstasy-of-rising-deposits/460897/

http://indianexpress.com/article/explained/return-of-market-stabilisation-bonds-with-some-differences-4400416/

http://www.financialexpress.com/economy/governments-october-march-borrowing-may-be-completed-ahead-of-schedule/461943/

http://www.financialexpress.com/opinion/demonetisation-banks-upset-but-rbis-100-crr-on-deposits-will-be-made-up-via-reverse-repo/459785/

http://www.livemint.com/Industry/UDyIxX8ZDuFmKr2D2t77jP/Govt-says-examining-proposal-on-MSS-bonds.html

http://www.moneycontrol.com/news/bonds-news/5-things-you-must-know-about-rbis-market-stabilisation-scheme_8032561.html

http://www.thehindubusinessline.com/money-and-banking/govt-raises-mss-cap-to-rs-6-lakh-crore-to-manage-liquidity/article9406591.ece

http://indianexpress.com/article/explained/return-of-market-stabilisation-bonds-with-some-differences-4400416/

http://www.financialexpress.com/opinion/demonetisation-for-banks-agony-of-surplus-liquidity-higher-than-ecstasy-of-rising-deposits/460897/

Advertisements

Categories: Story Of The Week