Government Bonds and MSS

I was asked the following on 21 May 07, 21:43:

Sreenadh: Why there is limit on govt bonds? how much interest govt pays on that. what is the benift of MSS over conventional ones.

My Answer:

Government cannot (and does not want to) borrow more money just because it can borrow more. It only wants to borrow only that much as is needed. Say if it wants to raise Rs. 30,000 crores in a year, it will only issue those many bonds. Even out of this also, there would be two types of issues – a short term one and a long term one. Long term bonds carry more interest and short term bonds usually carry lower interest rates. As Government’s banker, RBI manages these issues of bonds and raises the money required by Government. When the RBI doesn’t manage the issues, it can also buy the bonds of the Government and keep them with it and issue the money to the Government.

The RBI used to mop up excess liquidity (money floating) in the system by issuing the Government bonds in exchange for the value. When the RBI ran out of stock of the Government bonds, and it still found that there is excess liquidity in the system, it had to come out with an alternative. That is when the MSS (Market Stabilization Scheme) was launched. It issues bonds with a tenor varying between 3 months to 1 year.

MSS is one more method of mopping up excess liquidity in the system. There is nothing superior to it over the selling of Government bonds.