Open Market Operations by RBI
- 20 Mar 2021
- 5 min read
Why in News
The Reserve Bank of India (RBI) has decided to conduct simultaneous purchase and sale of government securities (G-Sec) under Open Market Operations (OMOs) for an amount of Rs. 10,000 crore each.
- Simultaneous purchase and sale of government securities under OMOs, popularly known as operation twist, involves purchasing G-Sec of longer maturities and selling equal amounts of G-Sec of shorter maturities.
- Open Market Operations:
- Meaning: Open Market Operations refers to buying and selling of bonds issued by the Government in the open market.
- One of the Quantitative Tools: OMO is one of the quantitative tools that RBI uses to smoothen the liquidity conditions through the year and minimise its impact on the interest rate and inflation rate levels.
- Quantitative tools control the extent of money supply by changing the Cash Reserve Ratio (CRR), or bank rate or open market operations.
- Qualitative tools include persuasion by the Central bank in order to make commercial banks discourage or encourage lending which is done through moral suasion, margin requirement, etc.
- Impact on Money Supply:
- When RBI buys a Government bond in the open market, it pays for it by giving a cheque. This cheque increases the total amount of reserves in the economy and thus increases the money supply.
- Selling of a bond by RBI (to private individuals or institutions) leads to reduction in quantity of reserves and hence the money supply.
- Two Types of OMOs: Outright and Repo.
- Outright OMOs are permanent in nature: when the central bank buys these securities (thus injecting money into the system), it is without any promise to sell them later. Similarly, when the central bank sells these securities (thus withdrawing money from the system), it is without any promise to buy them.
- This is a type of operation in which when the central bank buys the security, the agreement of purchase also has specification about date and price of resale of this security. This type of agreement is called a repurchase agreement or repo. The interest rate at which the money is lent in this way is called the repo rate.
- Similarly, instead of outright sale of securities the central bank may sell the securities through an agreement which has a specification about the date and price at which it will be repurchased. This type of agreement is called a reverse repurchase agreement or reverse repo. The rate at which the money is withdrawn in this manner is called the reverse repo rate.
- The Reserve Bank of India conducts repo and reverse repo operations at various maturities: overnight, 7-day, 14- day, etc. These types of operations have now become the main tool of monetary policy of the Reserve Bank of India.
- A G-Sec is a tradable instrument issued by the central government or state governments. It acknowledges the Government’s debt obligation.
- Short term securities (with original maturities of less than one year) are usually called Treasury Bills.
- Long term securities (with original maturities of more than one year or more) are usually called Government Bonds or Dated Securities.
- In India, the Central Government issues both treasury bills and bonds or dated securities while the State Governments issue only bonds or dated securities, which are called the State Development Loans (SDLs).
- G-Secs carry practically no risk of default and, hence, are called risk-free gilt-edged instruments.
- Gilt-edged securities are high-grade investment bonds offered by governments and large corporations as a means of borrowing funds.
- Recently, the Reserve Bank of India has proposed to allow retail investors to open gilt accounts with the central bank to invest in Government securities (G-secs) directly and without the help of intermediaries.