Market Stabilisation Scheme and Management of Liquidity in the Period of Volatile Capital Inflows: The Indian Experience

Abstract

India recorded large and exogenous capital inflow from the very beginning of this century. This made monetary and liquidity management increasingly complex and difficult in India. Independent monetary policy in the era of free and volatile capital flow became challenging. To deal with the problems of excess liquidity in the system, the Reserve Bank of India (RBI) in consultation with the Government of India (GOI) introduced Market Stabilisation Scheme (MSS) in April 2004 with the objective of impounding excess liquidity from the system. In this paper, we have attempted to examine whether MSS was effective as an instrument of sterilisation in absorbing excess liquidity from the system and enabled the RBI to manage the liquidity condition smoothly. This paper has found that MSS was an effective instrument of sterilisation that helped the RBI in managing liquidity conditions in the period of large and exogenous capital inflows. This paper has also found that MSS was even effective in injecting back liquidity into the system through unwinding of securities under MSS redemption and its buyback operations in the period of large capital outflows during the international financial crisis of 2008-09. This helped the large borrowing programmes of the government during 2009-10. The paper has estimated the cost of MSS operations and found it on the lower side considering the scale of operation of this scheme.