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Open Market Operation and Operation twist

  Aug 08, 2020

Open Market Operation and Operation twist

Reserve Bank has decided to conduct simultaneous purchase and sale of government securities under Open Market Operations (OMO) for ₹10,000 crores each on July 02, 2020 .

Q. What is Open Market Operations? 

  • Open market operations are the sale and purchase of government securities and treasury bills by RBI or the central bank of the country.
  • The objective of OMO is to regulate the money supply in the economy.
  • When the RBI wants to increase the money supply in the economy, it purchases the government securities from the market and it sells government securities to suck out liquidity from the system. RBI carries out the OMO through commercial banks and does not directly deal with the public.

Q. What is Operation twist? 

  • The tool essentially aims at changing the shape of the yield curve (hence the name twist) through simultaneous buying and selling of long- and short-term government bonds.
  • The intent is to moderate high long-term interest rates in the market and bring them closer to the repo rate.

Q. Why is it needed?

  • The RBI said it will buy long-dated government securities maturing between May-2027 and December 2033. On the other hand it will sell securities that mature between October 2020 and April 2021.
  • The sale of short-term securities will push up the short-term rate.
  • Experts say the move is necessary because the present market conditions in India have made investors/customers hesitant in making long-term investments or availing long term loans.
  • It may be noted that high market yields on long-term government securities often send interest rates on long-term loans soaring. This can affect customers seeking long term loans for vehicles, real estate, and other long-term borrowings.
  • As the central bank buys more long-term security and sells off short term bonds, the bond yield -the return an investor gets on his holding - comes down significantly.
  • Since long-term bond yield (10-year government securities) is a key market interest rate, lower rates can help people avail more long-term loans. It also helps in bringing down overall borrowing costs for the government.

Q. What is History of Operation Twist and how it started? 

A. In 1961, the John F Kennedy administration proposed a solution to revive the weak economy through lower longer-term interest rates while keeping short-term interest rates unchanged. This initiative is now known as ‘Operation Twist’ which was employed by the US Fed.

Q. What is Yield Curve? 

A. A yield curve is a graph of interest rate on all government bonds ranging from the short-term debt (one month) to long-term debt (could be high as 30 years).

Typically, the short term bond has lower interest rate compared with the long-term bond reflecting the higher perceived risk of the latter. Hence a graph of the interest rate of the short-term bond and longer-term will be an increasing line chart. This in technical parlance is called an upward sloping curve.