RBI may not opt for large scale MSS use to manage liquidity

Rather than rate cut, the liquidity management becomes a stressful issue for the RBI right now. When nearly 10 lakh crore rupees is returning to the balance sheet of the banking system, the first responsibility of the RBI is to ensure that banks will facilitate the re-monetization. They should not lend out of the temporary deposit.

Deposited money is not actual deposit rather a temporary monetary stock and will be quickly withdrawn by the people in the form of new currencies. To discourage banks from lending, the RBI has imposed 100 per cent CRR on deposits from September 16 onwards.

But the CRR is painful for banks as they have to give a short-term interest for deposits while no corresponding reward is obtained from keeping money with RBI in the form CRR.

Another option to manage the excess liquidity is issuing Market Stabilization Bonds. Here, government will give bonds to the RBI (the RBI will be a debtor to the government to the size of the bonds given by the government). When the RBI sells government securities under MSS, banks can purchase them while getting a return. From the banks’ point of view, this option is rewarding than the CRR.

But issue of MSS bonds have several constraints. First is that it is a time-consuming process. Already, government has increased the limit of MSS bonds to a historical high of Rs 6 lakh crores from the existing Rs 30000 crore.

The most important difficult is that government should allocate money in its budget to finance the interest payment for MSS bonds. This will create additional stress on the budget and government and the RBI doesn’t prefer this route to manage the excess liquidity. On the other hand, in the case of CRR, bank’s profitability will come down putting additional stress on its balance sheet.

The burden of liquidity management and its financial cost will be another adverse outcome of demonetization right now. 

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