After almost two years, the Reserve Bank of India (RBI) on Monday announced augmentation of market stabilisation scheme (MSS) to suck out liquidity from the system to keep inflation under check. The central bank has fixed a ceiling for the MSS outstanding at Rs 50,000 crore for 2010-11. In 2007-08, the RBI had built up Rs 2,50,000 crore of MSS which was majorly liquidated over next two years to provide liquidity to the system in the aftermath of global financial crisis.
KP Suresh Prabhu, chief bond trader at HDFC Bank, said, ?The central bank will use this tool by issuing MSS securities to absorb excess liquidity. Banks will place their investments in the short-term MSS papers issued by the RBI.?
Under this MSS scheme, the central bank issues bonds to suck out the additional cash in the banking system generated by its own intervention.
The RBI has said that the ceiling of Rs 50,000 crore will be reviewed when the outstanding amount reaches the threshold limit of Rs 35,000 crore.
Currently, the MSS outstanding balance (face value) stands at Rs 2,737 crore. This is due for redemption during the fiscal year 2010-11. Currently, there are massive capital inflows into the economy and the RBI has to select the option of steep rate hikes to remove inflationary pressures or deliver moderate hikes to strike a balance between inflation and exchange rate, said Moses Harding, head of global markets at IndusInd Bank. Starting in 2004, the RBI had used MSS as an open market operation to suck out liquidity for checking inflation due to huge capital inflows. Last year (2009-10), the RBI did not come up with any MSS issuances as capital inflows into the economy were pretty low.
?There was a crisis situation and so the RBI wanted to ensure that there is adequate liquidity in the system. Hence, it did not use the MSS facility,? said Golak C Nath, vice-president & economic advisor with Clearing Corporation of India. During the monetary policy in January 2010, the RBI hiked the cash reserve ratio (CRR) by a good 75 basis points and sucked out close to Rs 36,000 crore from the banking system.
However, there has not been a crunch in the liquidity situation as banks are flush with adequate liquidity. The central bank said inflation has emerged as a ?major concern?’ amid strengthening consumer demand, signaling the possibility of raising borrowing costs. ?In India, recovery has coincided with a significant build-up of inflationary pressures,?’ the RBI had said. Since December 2009, there have been signs of emergence of generalised inflation.? The central bank said inflation, currently stoked mainly by food prices, runs the risk of ?getting transmitted?’ to industrial goods and services as wages rise.
While anchoring inflation expectations becomes important in such a situation, addressing supply constraints would be critical for enhancing the effectiveness of any anti-inflationary policy measures, said economists.
?We expect the central bank to focus on managing liquidity and tempering inflation expectations,? Shubhada Rao, chief economist at Yes Bank, said.