Related Topic in KAS Prelims Syllabus:
Economy [Paper-II]: Recent fiscal and monetary policy issues and their impact, structure of Indian Banking and Non- Banking Financial Institutions and reforms
On December 19, 2019, the Reserve Bank of India decided to conduct its version of ‘Operation Twist’ through simultaneous purchase and sale of government securities under Open Market Operations (OMOs) for Rs 10,000 crore each on December 23.
What is Operation Twist?
- Operation Twist is the name given to a monetary policy tool that the US Federal Reserve had initiated to influence the prevailing rate of interest in the markets.
- 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.
- In India, the RBI put through its version of Operation Twist by buying 10,000 crore worth of 10-year government bonds while selling four shorter-term government bonds adding up to the same value.
- The intent is to moderate high long-term interest rates in the market and bring them closer to the repo rate.
Why Operation Twist now?
- The RBI slashed repo rate by 135 points to 5.15 percent this year but banks passed on only part of it.
- The one-year median marginal cost of funds based lending rate (MCLR) has declined only 49 basis points (bps).
- Operation Twist normally leads to lower longer-term yields, which will help boost the economy by making loans less expensive for those looking to buy homes, cars and finance projects, while saving becomes less desirable because it doesn’t pay as much interest.
- The central bank is keen that long-term rates are brought down to kickstart investment and revive the economy.
- The idea is that business investment and housing demand were primarily determined by longer-term interest rates.
What actually RBI is planning to do?
- The central bank has decided to purchase Rs 10,000 crore worth of one security — the 6.45 percent GS 2029. This is a long term 10-year bond.
- On the sell side, it has proposed to sell four securities for a total of Rs 10,000 crore — 6.65 percent GS 2020, 7.80 percent GS 2020, 8.27 percent GS 2020 and 8.12 percent GS 2020.
- All these four securities are short term, and maturing in 2020. When the RBI purchases 6.45 percent bond, demand is expected to rise, leading to lower long-term yield.
- On the other hand, sale of short-term securities will push up the short-term rate.
Operation Twist in US
- 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.
- The US Fed employed the policy. The Fed then implemented the ‘Operation Twist’ programme in late 2011 and 2012 to stimulate the economy hit by the global financial crisis.
What are Open Market Operations (OMOs)?
- Reserve Bank of India manages and controls the liquidity, rupee strength and monetary management through purchase and sale of government securities (G-Secs) in a monetary tool called Open market Operations.
- OMOs are the market operations conducted by the RBI by way of sale and purchase of G-Secs to and from the market with an objective to adjust the rupee liquidity conditions in the market on a durable basis.
- When the RBI feels that there is excess liquidity in the market, it resorts to sale of securities thereby sucking out the rupee liquidity.
- Similarly, when the liquidity conditions are tight, the RBI may buy securities from the market, thereby releasing liquidity into the market.