Article:
The Reserve Bank Of India (RBI) has announced its plan to simultaneously purchase and sell government securities under Open Market Operations (OMO) for ₹10,000 crore each on April 27, 2020. This decision, influenced by current and evolving liquidity and market conditions, is applying an approach known as ‘Operation Twist.’
An Introduction to Operation Twist
Operation Twist refers to the RBI’s concurrent selling of short-term securities and purchasing of long-term securities through Open Market Operations (OMO). This strategy aims to reduce long-term interest rates and boost short-term rates. The mechanism was first utilized by the US Federal Reserve in 1961 with the objective of strengthening the U.S. dollar and stimulating economic cash flow.
One highlight of this mechanism is the transition of short-term securities into long-term securities. The practice is part of a broader effort to lower long-term interest and increase short-term rates.
Impact of Operation Twist on the Economy
When the central bank opts to buy long-term securities (bonds), their prices rise due to increased demand. However, this results in a decrease in bond yield given the inverse relationship between bond prices and yields. The yield reflects the return an investor receives on bond investments, and it plays a critical role in determining interest rates. When yields are low, we see a decrease in interest rates.
As a result, lower long-term interest rates enable people to avail themselves of long-term loans such as those used to purchase homes or cars or finance projects at lower rates. This ultimately creates a stimulatory effect on consumption and spending which can potentially revive growth in the economy.
About Government Securities and Their Role
A Government Security (G-Sec) is a tradable instrument issued by either Central or State Governments and serves as an acknowledgment of the Government’s debt obligations.
Short-term securities, generally referred to as treasury bills, have original maturities of less than one year. These are issued in three tenors: 91-day, 182-day, and 364-day. Long-term securities, also known as Government bonds or dated securities, possess original maturity periods of one year or more.
In India, both treasury bills and bonds or dated securities are issued by the Central Government, whereas State Governments only issue bonds or dated securities, referred to as the State Development Loans (SDLs). G-Secs are considered risk-free gilt-edged instruments as they carry virtually no risk of default.
Role of Open Market Operations in Monetary Policy
Open Market Operations (OMO), employed by a country’s central bank, is a quantitative monetary policy tool used to control money supply in the economy. Other tools include methods such as repo rate, cash reserve ratio, and statutory liquidity ratio.
OMOs involve the RBI selling or purchasing government securities (g-secs) to adjust money supply conditions. RBI executes these OMOs via commercial banks, without directly dealing with the public. To remove liquidity from the system, g-secs are sold, and to infuse liquidity, g-secs are bought back.
Last Modified: February 7, 2024