This scheme came into existence following a MoU between the Reserve Bank of India (RBI)

and the Government of India (GoI) with the primary aim of aiding the sterilization operations
of the RBI.
Historically, the RBI had been sterilizing the effects of significant capital inflows on
domestic liquidity by offloading parts of the stock of Government Securities held by it. It is
pertinent to recall, in this context, that the assets side of the RBIs Balance Sheet (July 1 to
June 30) includes Foreign Exchange Reserves and Government Securities while liabilities are
primarily in the form of High Powered Money (consisting of Currency with the public and
Reserves held in the RBI by the Banking System). Thus, any rise in Foreign Exchange
Reserves resulting from the intervention of the RBI in the Foreign Exchange Markets (with
the intention, say, to maintain the exchange rate on the face of huge capital inflows) entails a
corresponding rise in High Powered Money. The Money Supply in the economy is linked to
High Powered Money via the money multiplier. Therefore, on the face of large capital
inflows, to keep the liabilities side constant so as to not raise the Supply of Money,
corresponding reduction in the stock of Government Securities by the RBI is necessary.
The MSS was devised since continuous resort to sterilization by the RBI depleted its limited
stock of Government Securities and impaired the scope for similar interventions in the future.
Under this scheme, the GoI borrows from the RBI (such borrowing being additional to its
normal borrowing requirements) and issues Treasury-Bills/Dated Securities that are utilized
for absorbing excess liquidity from the market. Therefore, the MSS constitutes an
arrangement aiding in liquidity absorption, in keeping with the overall monetary policy
stance of the RBI, alongside tools like the Liquidity Adjustment Facility (LAF) and Open
Market Operations (OMO).
The securities issued under MSS, termed as Market Stabilization Scheme (MSS)
Securities/Bonds, are issued by way of auctions conducted by the RBI and are done
according to a specified ceiling mutually agreed upon by the GoI and the RBI. They possess
all the attributes of existing Treasury-Bills/Dated Securities and are included as a part of the
countrys internal Central Government debt.
The amount raised under the MSS does not get credited to the Government Account but is
maintained in a separate cash account with the RBI and are used only for the purpose of
redemption/buy back of Treasury-Bills/Dated Securities issued under the scheme.
However, 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 stimulus expenditure requirements.
Treasury-Bills/Securities issued under MSS are matched by equivalent cash balances that are
held by the Government with the RBI. Such payments are not made from the MSS account
just as receipts due to premium or accrued interest on these Securities are not credited to it.
As and when MSS securities are issued by the RBI as well as the annual ceiling, when
decided, is notified through a press release. For the fiscal year 2010-11 the annual ceiling for
such securities outstanding stand at Rs. 50,000 crore, with a review due when the outstanding
reaches the threshold of Rs. 35,000 crore.