RBI and Operation Twist

  Aug 06, 2020

RBI and Operation Twist

What is Operation Twist?

Under 'Operation Twist' the RBI buys long-term bonds and sells short-term government securities (G-Secs) simultaneously. A conventional Operation Twist involves a central bank buying and selling securities of the same amounts.

Idea Behind Operation Twist

1.   India's economy is reeling under pressure due to a slew of factors including a slump in demand and lower consumption. The central bank has cut 135 basis points throughout the year, but has achieved little in terms of boosting demand.

2.   It is mostly because Indian banks are failing to transmit the cumulative rate cut passed on by the RBI to consumer.

3.   But with rising inflation and fiscal pressure, the RBI went for Operation Twist, which aims to get yields of long-term bonds lower without a cut in key interest rate.

4.   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.

5.   It may be noted that high market yields on long-term government securities often increase interest rates on long-term loans. This can affect customers seeking long term loans for vehicles, real estate, and other long-term borrowings.

6.   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.

What is purpose of Operation twist?

It is to reduce bond yield of G sec which means reduced cost of borrowing for government. This will come in handy for the government if it has to borrow more from the market in this fiscal or the next. The government is walking a tight rope on fiscal deficit management. Next financial year, the market expects government to borrow more. If the RBI does this exercise on a sustainable basis, this will bring down the overall cost of borrowing for government

Another beneficiary to the Operation Twist will be the banks that are actively participating in the process of buying short-term bonds from the RBI. The RBI is allowing these banks to buy short-term securities, selling long term bonds. That way, banks can redeem these bonds after a year and invest in productive lending purposes if they choose to, and provided there is a pick-up in demand. 

Why is Operation Twist so important?

Operation Twist is a move in which a central bank decides to simultaneously buy long-dated securities while selling short-term securities. The objective behind such an operation is management of the yield curve. Other central banks, including the US Federal Reserve, have used similar measures. This is the first time RBI has undertaken such an unconventional policy measure with the aim of flattening the yield curve by lowering longer rates to boost lending and growth. 

What is Bond yield?

The returns fetched b a bond. For example, suppose the interest is 7% of a bond of Rs.100. If it is sold for Rs.95 by the bold holder as his confidence in the economy is low. Then the yields rise as the buyer of the bond at Rs.95 gets more than 7%. Similarly, if the bond is sold at Rs.102, the yields go down. Thus, yields are a function of confidence in the economy. When bond yield increases it means, government need to pay more interest on its borrowing. Bond yield increases when there are less buyers for a bond, which forces bond issuing authority to offer more interest in order to attract buyers.