RBI may bring back Market Stabilisation Scheme

RBI may bring back Market Stabilisation Scheme
The Hindu Business Line, December 9, 2009, Page 6

Bid to mop-up liquidity as credit growth remains sluggish.

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The liquidity overhang is expected to mount over the next few weeks in view of large redemptions/interest payouts from Government securities and State Development Loans.
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C. Shivkumar, Bangalore

The Market Stabilisation Scheme (MSS) is likely to make a comeback as the Reserve Bank of India moves to remove excess liquidity from the banking system.

Bank officials said although there was intense speculation of an increase in the Cash Reserve Ratio (CRR) by at least 50 basis points over the next two weeks, there was also considerable nervousness on the impact. The speculation has mounted in view of the surging food price inflation which is currently at 17.5 per cent.

Some banks, especially American and British banks, are already speculating on the possibilities of a 50-basis-points hike in the CRR. The CRR is a zero interest balance that banks are expected to maintain with the RBI. Currently, this ratio is 5 per cent. An increase by another 50 basis points would result in removing about Rs 20,000 crore of excess liquidity. However, bankers said the flexibility for a CRR hike was limited. They said credit growth continued to be sluggish so far into the peak season and there were few takers for even sanctioned credit limits. Instead, bulk of the non-food credit offtake was mostly from the oil sector for meeting import payment obligations.

The sluggish credit offtake was apparent from the low incremental credit deposit ratio. The incremental CD ratio has remained stubbornly stuck to 35 per cent. Consequently, pushing up the CRR at this juncture, the bankers said, would in turn lead to a pass through impact, implying lending rates would also move up in tandem. The HDFC Bank's, Chief Economist, Mr Abheek Barua, however, disagreed and said, “CRR hike is a gentle way of signalling an exit from monetary expansion. Therefore, it need not necessarily translate into credit re-pricing.”

Money supply growth

Bankers though pointed to the broad money supply growth that is close to the RBI's revised target for the current financial year. The RBI target is 18 per cent, though the actual growth is 18.4 per cent. This was way below the levels of the corresponding period of fiscal 2007-08, when it was close to 24 per cent. Besides, bulk of the money supply growth is currently contributed by net bank credit to the Government sector, instead of bank credit to the commercial sector.

Borrowing holiday

The liquidity overhang, meanwhile, is expected to mount over the next few weeks in view of large redemptions/interest payouts from Government securities and State Development Loans. In addition, there will be a Government borrowing holiday for almost three weeks — between December 18 and January 8 next year. Inflows into bank deposits, particularly from non-repatriable deposits, have amounted during the last few weeks. In addition, there were also FII inflows, though the RBI has refrained from making any large interventions.

Bankers said the non-intervention was to mitigate any expansion in high-powered money. The cumulative liquidity impact of redemptions, inflows and the government borrowing holiday was estimated at Rs 40,000 crore. This liquidity surge was likely to be a short-term feature.

Given this situation, the preferred instruments for siphoning out the excess liquidity was more weighted in favour of fiscally neutral MSS security issuances.

Issuance of MSS securities and unwinding of the same was taken up last year as a counter cyclical response to the global crisis. Another alternative for mopping up liquidity is through – Cash Management Bill (CMB), banker said.

CMB is a short-term instrument of tenors less than 90 days. This is also an eligible SLR security. Bankers said that deployment of either of these instruments was likely to have the least impact on credit or even G-Sec yields while at the same time mop up excess liquidity effectively.