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What are Open Market Operations?

Topics Covered: Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.

What are Open Market Operations?


Context:

RBI has announced the following measures to cool the rising bond yields and assuage liquidity pressures that could arise due to advance tax outflows:

  1. Two more tranches of ‘Operation Twist’ aggregating Rs 20,000 crore.
  2. Term repo operations aggregating Rs 1 lakh crore in September.
  3. Created more room under the so-called ‘held to maturity’ (HTM) category, which Banks’ can utilise from September 1, 2020 to park their fresh G-Sec acquisitions.

What is ‘Operation Twist’?

‘Operation Twist’ is RBI’s simultaneous selling of short-term securities and buying of long term securities through open market operations (OMO). Under this mechanism, the short-term securities are transitioned into long-term securities.

How does RBI manage ‘Operation Twist’?

  • This operation involves buying and selling government securities simultaneously in order to bring down long-term interest rates and bolster short-term rates.
  • There is an inverse relationship between the bond prices and their yields. As the central bank buys long-term securities (bonds), their demand rise which in turn pushes up their prices.
  • However, the bond yield comes down with an increase in prices. Yield is the return an investor gets on his (bond) holding/investment.
  • The interest rate in an economy is determined by yield. Thus, lower long-term interest rates mean people can avail long-term loans (such as buying houses, cars or financing projects) at lower rates.
  • This also results in a dip in the expected returns from long-term savings which tilts the balance from saving towards spending. Hence, cheaper retail loans can help encourage consumption spending which is the largest GDP component in the economy.

Benefits:

  • 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.
  • Cheaper retail loans mean a boost in consumption and spending in the economy which in turn will revive growth.

What are Open Market Operations?

OMOs are the market operations conducted by the RBI by way of sale and purchase of G-Secs to and from the market with an objective to adjust the rupee liquidity conditions in the market on a durable basis.

  • When the RBI feels that there is excess liquidity in the market, it resorts to sale of securities thereby sucking out the rupee liquidity.
  • Similarly, when the liquidity conditions are tight, the RBI may buy securities from the market, thereby releasing liquidity into the market.

InstaLinks:

Prelims Link:

  1. Types of Government securities?
  2. What are T- Bills?
  3. Which government securities carry interest?
  4. Which securities are sold at discounted price?
  5. Difference between monetary vs fiscal policies.
  6. What is Operation Twist?

Mains Link:

  1. Discuss the significance of Operation Twist being conducted by RBI.

Sources: the Hindu.