The Reserve Bank of India and the government are understood to be taking a relook at the structure of market stabilisation bonds floated by the central bank as a sterilisation instrument.
According to banking sources close to the development, both the government and the regulator are considering various options to minimise the impact of interest rate on these bonds and bills on the fiscal deficit of the Centre.
Under the original structure, while the amount absorbed from the financial system as part of the sterilisation process is kept with the RBI under the newly created MSB account, the government has to pay for the interest accrued on these instruments to market players.
However, the amount absorbed from the system could not be utilised by the government for its developmental activities even through it is bearing the full interest cost.
The new government at the Centre is learnt to have expressed concern on the impact of interest cost on this scheme which is essentially a sterilisation instrument for monetary management by the RBI.
Various options are being considered to tackle this problem. One of the proposal is to compensate the government by paying the interest earned by deploying foreign exchange reserves sucked away from the system as part of sterilisation in the overseas market.
To that extent, the cost of interest payment by the government and its impact on fiscal deficit will be countered. Under the normal circumstances, RBI pays a yearly dividend to the government.
Secondly, there is a suggestion to push for a legal amendment to introduce a standing deposit facility, which will act as a window over and above the usual cash reserve ratio for managing excess liquidity.
After introducing the scheme in the new financial year, around Rs 30,000 crore (Rs 300 billion) worth bills and bonds have been used for sterilisation. However, with the interest rate outlook changing around the globe with an upward bias and uncertainty over policy issues, foreign exchange inflows have petered down.
As per the memorandum of understanding signed between RBI and the government, the central bank has proposed to the government to authorise such issuances under the market stabilisation scheme up to a specified ceiling to be mutually agreed upon between the government and the RBI.
The bills and securities issued under MSS would be matched by an equivalent cash balances held by the government. This is to ensure that there will be a marginal impact on revenue and fiscal deficit to the extent of interest payment done on bills/bonds under the MSS.
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