Context: The Reserve Bank of India (RBI) said by deploying its conventional and unconventional tools, the markets remained liquid and stable, which established conditions for a finance-led recovery of the economy ahead of the revival of demand.

Challenges for Indian Economy: 

  • The RBI  said that with the onset of COVID-19, financial institutions were faced with liquidity stress, loss of access to funding and tightening of financial conditions amid disruption of cash flows and working capital cycles.
  • There is an increase in government borrowings and the significant loss of revenue due to the lockdown.

RBI’s measures:

  • Targeted interventions by the RBI comprised Long Term Repo Operations (LTROs), outright Open Market Operations (OMO) purchases and Operation Twist.
  • A combination of aggressive policy easing, and the liquidity measures caused yields on G-Secs to drop to their lowest level in more than a decade. 

Effect of RBI's measures:

  • The surplus liquidity in the system ensured fixed and soft short-term rates relative to the policy repo rate.
  • It helped monetary policy transmission with positive spillovers to other segments of the market.
  • However, long-term rates have not fallen commensurately with short-term rates, steepening the G-Sec yield curve.
  • Access to finance: Targeted liquidity provision through LTROs and Targeted Long Term Repo Operations (TLTROs) brought down financing costs in the corporate bond market to decadal lows. 
    • TLTROs, complemented by the special refinance facilities provided to All India Finance Institutions (AIFIs), helped channelise liquidity to small and mid-sized corporates, including non-banking financial companies (NBFCs) and micro finance institutions (MFIs).
    • They eased the access of non-AAA rated bonds and led to record primary issuances. 
      • A primary offering is the first issuance of bonds from a private company for public sale. 
  • Rekindling risk appetite: It is reflected in compression of spreads of corporate bond yields over similar tenor G-Secs from the elevated levels witnessed in the last week of March 2020.
    • Note: Higher liquidity in the system is expected to make corporate bond investment less risky. The spread between the corporate bonds over government bonds narrows down in this case. 

What is LTRO?

  • Under LTRO, RBI will conduct term repos of one-year and three-year tenors of appropriate sizes for up to a total amount of Rs 1 lakh crore at the policy repo rate.
  • RBI introduced LTRO with a view to ensuring banks about the availability of durable liquidity at reasonable cost relative to prevailing market conditions, and to further encourage banks to undertake maturity transformation smoothly.

Open Market Operations

  • Open market operations is 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.

Operation Twist

  • Recently, 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. 
  • Operation Twist is the name given to a US Federal Reserve monetary policy operation, which involves the purchase and sale of government securities to boost the economy by bringing down long-term interest rates.
  • 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.
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