RSTV: THE BIG PICTURE- RBI’s OPERATION TWIST
The Reserve Bank of India will conduct a simultaneous sale and purchase of bonds, in a move seen by market participants as an attempt to bring longer-term yields lower. It is the first time the RBI has conducted a special open market operation (OMO) of this kind, similar to the ‘Operation Twist’ carried out in the United States near the start of the decade. Bond yields have been rising since the RBI unexpectedly left its key repo rate unchanged, even as it slashed its forecast for economic growth to its lowest in over a decade. The RBI said it will buy 100 billion rupees’ worth of the current benchmark 10-year bond while selling four bonds maturing in 2020 for an equivalent amount. The central bank said it had decided to conduct the special OMO after reviewing the liquidity & market situation and assessing financial conditions.
- It is the new buzz word in the money market ever since the Reserve Bank of India (RBI) made an announcement for the simultaneous purchase and sale of government securities on 19 December of a similar amount of Rs 10,000 crore. The same has been replicated on 26 December and 2 January with the auctions to take place
- This an unusual step by the RBI to flatten the yields curves.
- An open market operation (OMO) is where the RBI buys and sells securities to infuse or absorb liquidity in the system.
- But when the RBI does the same on both sides, it is different when the amounts are the same which means that overall liquidity does not get influenced at all.
- But what is done is that the RBI is buying the benchmark 6.45 percent 2029 paper which is the 10 year one. On the other hand, it sells various papers in the 2020 bracket which is less than one year.
- Now what happens is that when the RBI buys 10 years paper, the demand for the same goes up leading to an increase in price or decline in yields. The same happens when it sells short-term paper which banks buy that, in turn, increases the yield as supply increases reducing thus the prices.
- This attempt to sell short term and buy long term is essentially aimed at helping out the government to meet its borrowing requirement at a slight lower cost.
- Operation Twist normally leads to lower longer-term yields, which will help boost the economy by making loans less expensive for those looking to buy homes, cars and finance projects, while saving becomes less desirable because it doesn’t pay as much interest
Why Operation Twist is conducted?
- If there is a shortfall in long term investment in the country and the investors are reluctant to do long term investment in the economy, then the government tries to reduce the interest rate for the long term investment ventures.
- These long term investment venture includes; purchase of land/house, investment in infrastructure and securities, etc.
- The long-term investment will create jobs in the country which would lead to an increase in the demand for other products. So due to a positive atmosphere in the country, the holistic development of the entire country would take place
Why is this being done now?
- The idea is to lower the long-term yields to something more tuned to the RBI.
- At the time of the first simultaneous OMO announced, the 10-year yield was 6.75 percent and after the two rounds of Operation Twist has come down to 6.51 percent.
- Clearly the RBI is not satisfied and is going in for the third round too. It is also possible that this operation can continue until such time the yields come down to the level with which the RBI is satisfied. While the 2020 paper yields have not quite increased to the same extent, the overall differential has come down. The latest auction announced also involves 4 and 6 years paper purchase along with the 10 years paper.
- At the theoretical level, such operations are influencing the yield curve which should reflect the differential in the tenures as well as move all rates down as the repo rate has been reduced by the RBI by 135 bps last year.
- As the transmission to the market did not take place in the last policy when the repo rate was reduced in October, Operation Twist has been used to guide rates.
Benefits of Operation Twist
- The interest rate for the long term investment will come down so the investor will take more loans for long term investments.
- Address the worries of lack of transmission of repo rate cuts.
- The flow of money will increase in the country, and aggregate demand in all sectors of the economy will boost.
- The overall increase in productive activities will further create jobs in the economy.
How does it affect investors?
- Fixed income investors with higher exposure to long term debt will benefit from easing yield of long-term bonds.
- Consumers/borrowers will also profit from ‘Operation Twist’ as the retail loans will now get cheaper.
- Previously banks were forced to price their retail loans at higher rates owing to high yields on long-term government borrowings.
- Cheaper retail loans mean a boost in consumption and spending in the economy which in turn will revive growth.