RBI to Restart Operation Twist
- 24 Apr 2020
- 4 min read
Why in News
The Reserve Bank Of India (RBI) has decided to conduct simultaneous purchase and sale of government securities under Open Market Operations (OMO) for ₹10,000 crore each on April 27, 2020 considering the current and evolving liquidity and market conditions.
- Such Open Market Operations are known as ‘Operation Twist,’ which was used by the RBI in December, 2019 for the first time.
- Operation Twist is the RBI's simultaneous selling of short-term securities and buying of long term securities through Open Market Operations (OMO) in order to bring down long-term interest rates and bolster short-term rates.
- Operation Twist was first used in 1961 by the US Federal Reserve (central bank) as a way to strengthen the U.S. dollar and stimulate cash flow into the economy.
- Under this mechanism, the short-term securities are transitioned into long-term securities.
- Impact of Operation Twist:
- As the central bank buys long-term securities (bonds), their demand rises which in turn pushes up their prices.
- However, the bond yield comes down with an increase in prices (inverse relationship).
- Yield is the return an investor gets on his (bond) holding/investment.
- The interest rate in an economy is determined by yield. If yield is low, interest rates decrease.
- 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 will lead to a boost in consumption and spending in the economy which in turn will revive the growth.
- A G-Sec is a tradable instrument issued by the Central Government or the State Governments.
- It acknowledges the Government’s debt obligation. Such securities are:
- Short term securities
- They are usually called treasury bills, with original maturities of less than one year- presently issued in three tenors, namely, 91 day, 182 day and 364 day.
- Long term securities
- They are usually called Government bonds or dated securities with original maturity of one year or more.
- Short term 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.
Open Market Operations
- Open Market Operations (OMO) is one of the quantitative monetary policy tools which is employed by the central bank of a country to control the money supply in the economy.
- Other monetary policy tools are such as repo rate, cash reserve ratio and statutory liquidity ratio, etc.
- OMOs are conducted by the RBI by way of sale or purchase of government securities (g-secs) to adjust money supply conditions.
- RBI carries out the OMO through commercial banks and does not directly deal with the public.
- The central bank sells g-secs to remove liquidity from the system and buys back g-secs to infuse liquidity into the system.