Market Stabilization Scheme (MSS)

The Market Stabilization Scheme is a policy introduced by the RBI in 2004. The main aim of this scheme is to withdraw excess money supply from the system by selling securities in the economy. The sale of government bonds achieves this. The market stabilization scheme was introduced after an MoU between the Indian government and the Reserve Bank of India took place. The primary aim of this scheme was to help the sterilisation process in the RBI. 

Purpose of MSS

The primary purpose behind the establishment of MSS was to withdraw the excess liquidity in the system. The main reason behind this liquidity is the purchase of foreign currency by the RBI in the foreign exchange market. Appreciation is not considered suitable for exports; therefore, RBI intervened in the foreign market. The purchase of dollars marked this intervention. For the purchase of dollars, a rupee has to be given in exchange. This giving out of the rupee created a space for inflation. 

To overcome the inflation thus created, RBI sells government bonds regularly. This helps to maintain the amount of liquidity in the system. And this process by which excess liquidity is withdrawn is known as sterilisation.

During 2007 and 2008, RBI sold out 2.5 lakh crore INR worth of securities. This simply implies that 2.5 lakh crore of money was sterilised.

Need for the formation of MSS

When the Indian government declared demonetisation and all the Rs.500 and Rs.1000 notes were banned immediately, a feeling of fear conquered the entire population. They didn’t know what to do with the cash they held in their pockets. They all rushed to the banks.

After demonetisation, people deposited a large amount of money into the banks. Banks cannot simultaneously lend this money back to the customers as this money was a part of temporary deposits. In such a scenario, banks will suffer loss as they will have to pay additional interest to the depositors. RBI thus instructed the banks to keep these quick deposits in the form of CRR. 

Banks put the excess money thus obtained into the MSS. In this way, banks earn interest as well. The MSS policy came into play to compensate for this additional interest paid by the banks. After demonetisation, RBI was allowed to sterilise money as significant as 6 Lakh crore. Earlier, this limit was set to 0.3 Lakh crore before demonetisation was announced.

Outflow of MSS

The money that will be obtained under the money sterilisation scheme will be kept under the RBI. It will never be transferred to the government. This is because if the money is transferred to the government, it will be used for the country’s economic development, thereby adding to the liquidity of the funds. Financial institutions purchase the securities or bonds that are out in the MSBs by the RBI. These companies receive interest for the purchase of these MSBs. 

The money received from selling these funds is kept under the RBI. The interest payment is simultaneously made to the buyers. For the payment of the interest, the government of India provides funding to the RBI from its budget. This money spent on the service expenses is known as the carrying cost. 

Market Stabilization Bonds 

 When the liquidity in a system increases, the money is transferred in the form of securities. These securities are government bonds that are sold to overcome inflation. We call these securities issued under the market stabilisation scheme Market Stabilization Bonds. The government of India owns these securities, and the Reserve Bank of India issues them. 

Conclusion

The market stabilisation scheme plays a significant role in the stabilisation of the economy of the country. All the funds that cause inflation in the system are invested into MSBs. These bonds are under the direct control of the government and are sold out by the RBI. The main reason behind the introduction of this scheme was to monitor and balance the inflation that was created due to the purchase of dollars in the foreign exchange market.