Market stabilisation fund mooted

An internal Reserve Bank of India committee has suggested setting up of a new market stabilisation fund for excess liquidity management.

The fund will issue debt to complement the stock of government bonds that the RBI has been running out in its continuous strive to suck out excess liquidity from the banking system.

The reports of the internal group on liquidity adjustment facility as well as that of the working group on instruments on sterilisation -- put up on RBI website on Tuesday -- proposed a slew of new tools to manage the liquidity overhang on the back of surging inflows of foreign money into the economy. The RBI is inviting comments on the proposals till December 31.

The recommendations include extending the maturity of short-term repos and reverse repos to one week to have a stronger impact on the money market and introducing a standing deposit type facility distinct from banks' cash reserve ratio besides repositioning of bank rate and reduction in interest rate on CRR.

It also said bank rate and the rate at which RBI refinances commercial bank debt, should be raised to the reverse repo rate of 6.5 per cent, from 6.0 per cent.

This will be the upper end of a proposed interest rate "corridor" while the rate on CRR will be the floor. The report proposed cutting the interest on CRR to below the repo rate of 4.5 per cent. At present, CRR attract earn interest at the bank rate.

The working group felt that "remuneration of eligible cash balances at bank rate is no longer justifiable and hence, recommends that remuneration of CRR, if any, be delinked from the bank rate and placed at a rate lower than the repo rate".

"Introduction of the standing deposit facility becomes essential for more flexibility to RBI in using the repo facility as a signaling device," the report said.

The expert group on sterilisation also did not rule out using CRR as an useful tool for sterilising excess liquidity in future.

"Use of CRR as an instrument of sterilisation, under extreme conditions of excess liquidity and when other options are exhausted, should not be ruled out altogether by a prudent monetary authority...," it said.

The group said pending amendments to the RBI Act, the central bank should explore the possibilities of modifying the current CRR provision to accommodate a standing deposit type facility.

The banks may be permitted to place deposits with the RBI at their discretion over and above the required CRR deposits.

Such deposits may be deemed as part of CRR with a flexible interpretation of the extant provisions of the RBI Act, the report said.

The RBI has already made proposals to the government to have the flexibility to change CRR even below the current statutory minimum of 3 per cent as also to pay interest on such balances actually maintained with it by scheduled banks.

The distinguishing feature of this facility was that the placement of such deposits was at the discretion of banks unlike CRR, which was applicable to all banks irrespective of their liquidity position.

The stabilisation fund has been proposed "for mopping up enduring surplus liquidity from the system over and above the amount that could be absorbed under the day to day repo operations of LAF."

This fund could issue market stabilisation bills/bonds (MSBs) for mopping up enduring surplus liquidity from the system over and above the amount that could be absorbed under the day-to-day repo operations of LAF. The MSBs might be raised through auctions and permitted to trade in the secondary market.

The amounts raised will be credited to mutual funds, maintained and managed by the RBI. The maturity, amount and timing of issue of MSBs might be decided by the central bank in consultation with the government, it said.

Major recommendations for use of various instruments for sterilisation

Use of existing instruments not requiring amendment to the RBI Act:

• It is not desirable to use the LAF as an instrument of sterilisation on an enduring basis; however , for limited periods, it can be used in a flexible manner along with other instruments.
• Open market operations of outright sales of government securities should continue to be an instrument of sterilisation to the extent that securities with the RBI can be utilised for the purpose. However an alternative of using existing stock of securities for longer term repos ( up to 3-6 months ) as an option can be also considered.
• Surplus balances of the government may be maintained with the RBI without prepayment of interest so as to release securities for OMO, with the review of 1997 agreement between the government and RBI.
• Use of CRR as an instrument of sterilisation under extreme conditions of excess liquidity and when other options are exhausted should not be ruled out altogether by a prudent monetary authority ready to meet all eventualities.

Use of new instruments requiring amendment to the RBI act

• The RBI Act may be amended to provide for flexibility in determination/remuneration of cash reserve ratio balances so that interest can be paid on deposit balances actually maintained by scheduled banks with the central bank. The RBI has already recommended to the government to have the flexibility to change CRR even below the current statutory minimum of 3 per cent as also to pay interest on such balances actually maintained with it by scheduled banks.
• In the context of current fiscal situation and considerations of market fragmentation, it is not desirable to pursue the option of issuance of central bank paper.
• Use of new instrument not requiring amendment to the RBI agreement:
• The government may issue market stabilisation bonds/bills ( MSBs) for mopping up liquidity from the system. The amounts so raised should be credited to a fund created in the public account and the fund should be maintained and operated by the RBI in consultation with the RBI.