In recent news, the Reserve Bank of India (RBI) has declared several new measures to maintain orderly market conditions and financial stability in the face of ongoing economic challenges. These include additional tranches of special Open Market Operations (OMOs) in bonds and an increase in the Held-To-Maturity (HTM) limit under the Statutory Liquidity Ratio (SLR) for banks.
‘Operation Twist’ – An Effort to Boost the Economy
The RBI’s strategy has been named as ‘Operation Twist’, originating from a monetary policy operation by the USA Federal Reserve. This strategy involves the buying and selling of government securities to bolster the economy by reducing long-term interest rates. The RBI has now adopted this tactic within the Indian economic framework.
Open Market Operations – An Instrument to Control Money Supply
The RBI will carry out more open market operations totalling Rs. 20,000 crores, following similar operations conducted in March. OMOs refer to simultaneous sale and purchase of government securities and treasury bills, carried out with the aim to control the money supply in the economy. This is done through commercial banks, with the RBI not directly dealing with the public. OMOs are one of the many quantitative tools utilised by the RBI to smoothen liquidity conditions throughout the year and lessen its impact on interest rate and inflation levels.
Term Repo Operations – Easing Liquidity Pressures
To alleviate liquidity pressures on the market, the RBI will undertake term repo operations amounting to Rs. 1,00,000 crore at the existing repo rate in mid-September. To reduce the cost of funds, banks that have taken funds under Long-Term Repo Operations (LTROs) may opt to reverse these transactions prior to maturity. The LTRO allows banks to borrow one to three-year funds from the RBI at the repo rate by providing government securities of similar or longer tenure as collateral.
Held-To-Maturity Limit Increase – Offering More Flexibility to Banks
The RBI has increased the limit on bonds held-to-maturity (HTM) from 19.5% to 22% of Net Demand and Time Liabilities (NDTL). This change provides banks with more room to purchase additional bonds without worrying about short-term yield fluctuations. HTM securities are debt securities procured with an intention to retain them until they mature.
Key Financial Terms Explained
– Repo Rate: The interest rate at which the RBI lends money to commercial banks.
– Government Securities (G-Sec): Tradable instruments released by either the central or state governments. They differ based on short term (Treasury Bills) and long term (Government Bonds or Dated Securities).
– Net Demand and Time Liabilities (NDTL): Represents the difference between a bank’s total demand and time liabilities (deposits) and the deposits held as assets by other banks.
Navigating through the Global Financial Crisis
Due to the global financial crisis in the wake of the Covid-19 pandemic, the steps taken by the RBI aim to ensure the orderly functioning of India’s financial market. The measure of a six-month moratorium on repayment of debt began on 1st March 2020 to assist businesses and individuals experiencing financial difficulties due to disruption in normal business activities. However, this measure ended on 31st August 2020, potentially impacting small businesses already grappling with financial challenges brought on by the Covid-19 pandemic.
As part of its approach to address the ramifications of the Covid-19 crisis, the RBI announced its use of the Dynamic Stochastic General Equilibrium (DSGE) model. This model will provide an assessment of the pandemic’s likely impact on the Indian economy. Combined with the recently announced GDP contraction of 23.9%, the conclusion of the six-month moratorium could further strain the market.
Addressing Financial Health Amid Challenges
India’s financial health is currently challenged by Non Performing Assets (NPAs), bank frauds and economic setbacks due to Covid-19 as stated in the RBI’s annual report. Addressing these issues will require an extensive set of monetary reforms, including an assortment of instruments for market operations as required.
