to make it internationally reputable, accelerate the pace of reforms and develop it into a constructive usher of an efficient, vibrant and competitive economy by adequately supporting the country's financial needs.
Eventually, in order to have greater flexibility in liquidity management, the LAF was operated through overnight fixed rate repo and reverse repo effective from November 1, 2004.
In a surplus liquidity condition, the reverse repo rate becomes the operating policy rate. In a deficit liquidity situation, the repo rate becomes the policy rate.
FROM MAY 2011, only repo rate was announced and reverse repo was linked to it. The reverse repo rate is fixed at 100 basis points below the repo rate
Definition of 'Sterilization'A form of monetary action in which a central bank or federal reserve attempts to insulate itself from the foreign exchange market to counteract the effects of a changing monetary base. The sterilization process is used to manipulate the value of one domestic currency relative to another, and is initiated in the forex market.
HOW WAS IT INTRODUCED After the BoP crisis and pressure from internationalorganizations like IMF and World bank, The GOI took severalsteps to remodel the countrys financial system.The banking sector, handling 80% of the flow of money inthe economy, needed some serious reforms.In the light of these requirements, two expert Committeeswere set up in 1990s under the chairmanship of M.Narasimham which are widely credited for spearheadingthe financial sector reform in India.
The report recommended that the RBI withdraw fromthe 91-day treasury bills market and that interbank callmoney and term money markets be restricted to banksand primary dealers.Pursuant to the recommendations, the RBI introduceda Liquidity Adjustment Facility (LAF) operated throughrepo and reverse repos to set a corridor for moneymarket interest rates.In April 1999, an Interim Liquidity Adjustment Facility(ILAF) was introduced pending further up gradation intechnology and legal/procedural changes to facilitateelectronic transfer.
Transition from ILAF to LAFIn the first stage, w.e.f. june 5, 2000, fixed rate reverse repo gaveway to variable rate reverse repo auctions.In the second stage, the repo rate was unified to the Bank Rate,Thus, the repo rate emerged as the lending rate of the RBI for allpractical purposes.The third stage of full-fledged LAF began with the fullcomputerization of the Public Debt Office (PDO) and theintroduction of the Real Time Gross Settlement (RTGS)system enabling repo operations mainly through electronictransfers and the operation of LAF at different times of the sameday.
What Does It MeanLiquidity adjustment facility (LAF) is a monetary policy toolwhich allows banks to borrow money through repurchaseagreements. LAF is used to aid banks in adjusting the day today mismatches in liquidity. This arrangement allows banksto respond to liquidity pressures and is used bygovernments to assure basic stability in the financialmarkets.LAF consists of repo and reverse repo operations.
Repo or repurchase option is a collaterised lending i.e.banks borrow money from Reserve bank of India to meetshort term needs by selling securities to RBI with anagreement to repurchase the same at predetermined rateand date. Repo operations therefore inject liquidity intothe system. Repo transactions are usually made when thecall rate is below the repo rateReverse repo operation is when RBI borrows money frombanks by lending securities. The interest rate paid by RBIis in this case is called the reverse repo rate. Reverse repooperation therefore absorbs the liquidity in the system.Reverse Repo transactions are usually made when the callrate is above the repo rate
LAF CORRIDOR: THE DIFERENCE BETWEEN REPO AND REVERSEREPO RATE ALLOWS FOR THE CALL MONEY RATE TO FLUCTUATE
WHY MSS IS INTRODUCED ?• In year 2004, FIIs (Foreign Institutional Investors) started bringing in dollars to buy Indian stocks.• This results in an oversupply of US dollars in the Indian market.• RBI bought dollars to create an equivalent amount of rupees.• This dollar buying raised forex reserves from $100 bn in January 2004 to about $300 bn by 2007-08.• Thus leads to liquidity overhang• This has forced the government to mop up the rupees by creating the MSS bonds.
INTRODUCTION• MSS was introduced as an agreement between the government of india (GoI) and the Reserve Bank of India (RBI) in early 2004.• Under the scheme, RBI issues bonds on behalf of the government and the money raised under bonds is impounded in a separate account(called MSS cash account) with RBI and are used only for the purpose of redemption/buy back of Treasury-Bills/Dated Securities issued under the scheme.
• The bills/bonds issued under MSS would have all the attributes of the existing Treasury Bills and dated securities.• The bills and securities will be issued by way of auctions to be conducted by the Reserve Bank.• The Reserve Bank will decide and notify the amount, tenure and timing of issuance of such treasury bills and dated securities.• Whenever such securities are issued by the Reserve Bank for the purpose of market stabilisation and sterilisation, a press release at the time of issue would indicate such purpose
• In 2003-04, the total outstanding obligations of the Government by way of bills/securities thus issued under the MSS from time to time would not exceed Rs. 60,000 crore.• The Reserve Bank of India (RBI) has capped the outstanding balance under the market stabilization scheme (MSS), for the fiscal year 2012-13 at 50,000 crore ($9.7 billion).
• Following the global financial crisis of 2008, that necessitated fiscal stimulus measures, an amendment to the original MoU between the RBI and the GoI in February 2009 allowed the Government to convert a portion of the MSS funds into normal government borrowing for financing its expenditure requirements.
IMPACT ON FISCAL/REVENUE DEFICIT• The bills and securities issued for the purpose of MSS would be matched by an equivalent cash balance held by the Government with the Reserve Bank. Thus, there will only be a marginal impact on revenue and fiscal deficits of the Government to the extent of interest payment on bills/securities outstanding under the MSS. Further, the cost would be shown separately in the Budget. This would add transparency to the cost of sterilisation.
CURRENT RATES AND RATIOS• Repo Rate under LAF- 7.50% (w.e.f.19/03/2013)• Reverse Repo Rate under LAF - 6.50% (w.e.f.19/03/2013)• Bank rate- 8.50% (w.e.f. close of business of 19/03/2013)• Cash Reserve Ratio (CRR)- 4.00% (wef 09/02/2013)• Statutory Liquidity Ratio (SLR)-• 23%(w.e.f. 11/08/2012)