An ATM without cash in Ranchi on Tuesday. (Hardeep Singh)

Jayanta Roy Chowdhury and Vivek Nair, TT, Nov. 29: The Centre is likely to raise the issuance limit on market stabilisation scheme (MSS) bonds - a seldom used liquidity-soaking device conceived in 2004 - from its current level of Rs 30,000 crore.

The limit is likely to be raised by Rs 50,000 crore, enabling the Reserve Bank of India (RBI) to use an instrument to blunt the inflationary impulse stemming from the cash trove that has burst into the system after lurking for years in homes under mattresses or in hidden vaults.

Surprised by the sudden deluge of deposits after the demonetisation announcement on November 8, the RBI has been scrambling to soak up the tide of cash that has poured into the banking system in the past three weeks.

Last Saturday, the central bank slapped an additional 100 per cent cash reserve ratio (CRR) on the incremental deposits that banks had received between September 16 and November 11, effectively sopping up Rs 3.4 trillion worth of cheap funds funnelled into current and savings bank accounts that pay zero to very low interest rates.

Sources in Delhi said a decision on raising the MSS bond issuance limit could be taken later this week.

In an interview to news agency PTI this weekend, RBI governor Urjit Patel had said the central bank would "review" its decision on slapping the incremental cash reserve ratio (CRR) if the government raised the amount under the Market Stabilisation Scheme (MSS).

Later, economic affairs secretary Shaktikanta Das had said the Centre had received such a proposal from the RBI and that it was under active consideration of the government.

Bond market circles said a revision in the MSS limit would need Parliament's approval.

The bills or bonds issued under MSS would have all the attributes of the existing short-term treasury bills and longer-tenure dated securities. The bills and securities will be issued by way of auctions conducted by the Reserve Bank.

However, it is learnt that one section within the finance ministry is resisting the move to raise the MSS bond limit on the ground that it could have a negative impact on the treasury bill yields.

The government's borrowing programme budgeted at Rs 6 lakh crore in this year's budget is largely dependent on dated securities. But it meets its short-term borrowing requirements by floating 91-day, 182-day, and 364-day treasury bills.

The big question is whether the central bank will close out the 100 per cent additional CRR on incremental deposits raised by banks when it reviews the decision on December 9.

Banks had been exultant over the sudden access to cheap funds as a result of the demonetisation-induced deposit rush and had raised the prospect of cutting lending rates across the board.

India Inc has been clamouring for further rate cuts to kick start growth in a faltering economy. The GDP numbers for the second quarter ended September 30 come out tomorrow and will be closely watched. The first quarter ended June 30 had seen growth slow to 7.1 per cent from 7.9 per cent in the January-March quarter (fourth quarter of fiscal 2015-16).

"The markets are expecting that as soon as the MSS hike is approved and MSS bonds are to be issued, this extraordinary measure of slapping a CRR hike will drop off," K. Harihar, head of fixed income, currency & commodities at FirstRand Bank, told The Telegraph.

The expectation is that the more than Rs 3 trillion impounded by the RBI will be returned to banks. But the central bank may not do this in one stroke and opt to release the sum in dribbles lest it trigger volatility in the markets.

On Monday, the RBI said that exchange of old currency and the deposits in bank accounts from November 10 up to November 27 amounted to Rs 844,982 crore. Of this sum, deposits amounted to Rs 811,033 crore. Banks have been parking the huge liquidity at the reverse repo window of the RBI or buying bonds since credit growth has been tardy.

Banking circles said the huge liquidity with banks would also depend on how much money is withdrawn in the coming days. The withdrawals may increase once the authorities relax the current limits.

The banks were also worried as the additional 100 per cent CRR was a double whammy for them. They would have to incur a cost because of the interest they would have to pay on a large chunk of the deposits while not being able to earn anything on the sequestered reserve with the RBI.

Rating agency ICRA estimates that because of the above changes, the banks could lose Rs 700 to 900 crore every fortnight till such time that the RBI reverses its temporary measure. The surge in deposits was expected to result in a decline in the cost of bank funds.

"Banks may take a pause on monetary transmission as they await further directions from the regulator," the ICRA said in a note.

The RBI has cut interest rates by 175 basis points since January 2015 from 8 per cent to 6.25 per cent at present. Banks have passed on less than half of the policy rate cut to their customers - delaying the monetary policy transmission on the ground that their cost of funds remained high.

The surge in deposits after the demonetisation announcement was expected to destroy the basis of that argument and escalate pressure on them to hasten the pace of lending rate cuts. This will now crucially depend on whether or not Urjit Patel reverses the decision on the additional CRR.