Pushing Boundaries: RBI’s Operation Twist

Open Market Operations, a common tool used by central banks to regulate the money supply in the economy, usually involves purchasing government securities to increase liquidity or selling government securities to suck out the liquidity from the system. The ‘twist’ in the operation, also known as ‘Quantitative Easing’, occurs when the central bank uses the proceeds of the sales from short term bonds to buy long-term securities.

In a first for the RBI, it began its operation twist on December 23, 2019.

THE ACTION:

RBI’s simultaneous action of purchase and sale includes buying Rs. 10,000 Cr of 10-year long term government bonds and selling Rs. 10,000 Cr of 4 G-Secs short term bonds of the 2020 series with the hope of influencing bond yields and managing the yield curve.

India’s Operation Twist: RBI to buy 10-year long-term bonds

India’s Operation Twist: RBI to sell short-term bonds

THE MOTIVE:

RBI’s measures in the past 6 months resulted in a notable rally in short-term bonds, resulting in surplus liquidity. Therefore, the rate of transmission was effective for short-term rates. Meanwhile, though, the overall fiscal concerns kept the long-term rates elevated. This move is aimed at bringing down the spiralling cost of long-term borrowing and reducing India’s long-term yields. It also aims at pushing up rates of shorter tenor bonds, which have been trading below the repo rate. This simultaneous action of buying and selling is done with the aim of flattening the yield curve and bridge the liquidity gap.

EXPECTED OUTCOME:

It aims at ensuring the effective transmission of rate cut benefits to consumers and businesses, ultimately boosting demand for credit and spurring growth. Lower fixed rates allow businesses to expand more economically. The result is an expanding economy. It could also result in a windfall to some Mutual Fund investors, with long-duration and dynamic bond funds benefiting from this move.

THE IMPACT:

The yield of the 2029 bonds (long-term bonds) fell by 15 bps to 6.6%, as of 23 December 2019.
The yield of 2020 bonds (short-term bonds) jumped up by 20 bps as of 23 December 2019.

OPEN MARKET OPERATIONS AROUND THE WORLD:

This operation twist may be a first for the RBI, but it is not new for central banks around the world. RBI’s Operation Twist is similar to the US Fed Reserve’s version in 2011-12. The US Fed uses Open Market Operations regularly as a key tool in its implementation of monetary policies, including putting downward pressure on longer-term interest rates and aid the accommodative stance in the financial conditions.

The Eurosystem’s regular open market operations consist of one-week liquidity-providing operations in euro (main refinancing operations, or MROs) as well as three-month liquidity-providing operations in euro (longer-term refinancing operations, or LTROs). The most recent refinancing operations that we saw was the ECB’s announcement of the third series of Targeted Longer-term Refinancing Operations (TLTRO III) in September 2019. This move aimed at maintaining favourable lending conditions, ensuring the smooth functioning of monetary policy transmissions and supporting the accommodative stance of the monetary policy. The ECB also started Quantitative Easing from November 1, 2019.

China’s central bank, the People’s Bank of China, uses Open Market Operations among seven other tools to adjust its monetary policy. When it sells short-term bonds to some commercial banks through its repurchase agreements, it reduces liquidity from the system. It also does the opposite by buying up those contracts in reverse repurchase agreements, thereby ensuring more liquidity for the banks.

We sign off with the current hope that the RBI is keen on ensuring that the rate cuts will ultimately benefit the borrowers and bring about a much-needed respite to the economy.

https://Kamarati.com.ua