Context:The Reserve Bank of India (RBI) has recently announced simultaneous purchase and sale of government bonds in a bid to soften long-term yields.
More about the news:
- Open Market Operations(OMO):
- RBI will buy ₹10,000 crore of bonds maturing between 2026 and 2030 and sell the same amount of T-bills.
- It will buy longer tenor bonds with 6-10 year maturities while simultaneously selling shorter duration papers maturing between June this year and April next year.
- This is the second instance when RBI has used operation twist after the first use in December last year.
- Reducing impact of COVID-19 on the economy
- On a review of current and evolving liquidity and market conditions,which are impacted by COVID-19,RBI has decided to go ahead with the OMOs.
- Impact of the RBI’s move
- The yields on the 10- year bonds dropped by 20 basis points (bps).
- The move will also aid the process of monetary transmission by prompting banks to pass on interest rate cut benefits to their customers.
- ‘Operation Twist’ is when the central bank uses the proceeds from the sale of short-term securities to buy long-term government debt papers
- It is aimed at easing of interest rates on the long term papers.
- This monetary policy tool called "Operation Twist" was first used by the Us Federal Reserve in 1961.
- It was used when the US economy was recovering from recession post the Korean war.
- 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.
Purpose for Conducting Operation Twist
Advantages of Operation Twist
- The interest rate for the long term investment will come down so the investor will take more loans for long term investments.
- Address the worries of lack of transmission of repo rate cuts.
- The flow of money will increase in the country, and aggregate demand in all sectors of the economy will boost.
- The overall increase in productive activities will further create jobs in the economy.
Bond yields as an economic indicator
- Bond yield is inversely proportional to its current value. The greater the yield, the lower the current market price of the bond.
- As investors sell government bonds, prices drop, and yields increase.
- A higher yield indicates greater risk. If the yield offered by a bond is much higher than what it was when issued, there is a chance that the company or government that issued it is financially stressed and may not be able to repay the capital.
About Open Market Operations(OMO)
- It is the sale and purchase of government securities and treasury bills by RBI or the central bank of the country.
- Objective: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.
- OMO is one of the tools that RBI uses to smoothen the liquidity conditions through the year and minimise its impact on the interest rate and inflation rate levels.
Government Securities (G-Sec)
- It is a tradable instrument issued by the Central Government or the State Governments.
- It acknowledges the Government’s debt obligation. Such securities are
- Short term (usually called treasury bills, with original maturities of less than one year) OR
- Long term (usually called Government bonds or dated securities with original maturity of one year or more).
- In India, the Central Government issues both, treasury bills and bonds or dated securities while the State Governments issue only bonds or dated securities, which are called the State Development Loans (SDLs).
- G-Secs carry practically no risk of default and, hence, are called risk-free gilt-edged instruments.
- How are G-Secs issued?
- They are issued through auctions conducted by RBI. Auctions are conducted on the electronic platform called the E-Kuber,
- It is the Core Banking Solution (CBS) platform of RBI.
- Commercial banks, scheduled UCBs, Primary Dealers,insurance companies and provident funds, who maintain funds account and securities accounts with RBI, are members of this electronic platform.
- Treasury bills or T-bills, which are money market instruments, are short term debt instruments issued by the Government of India and are presently issued in three tenors, namely, 91 day, 182 day and 364 day.
- Treasury bills are zero coupon securities and pay no interest. Instead, they are issued at a discount and redeemed at the face value at maturity.
State Development Loans (SDLs)
- State Governments also raise loans from the market which are called SDLs.
- SDLs are dated securities issued through normal auction similar to the auctions conducted for dated securities issued by the Central Government.
- Interest is serviced at half-yearly intervals and the principal is repaid on the maturity date.
- Like dated securities issued by the Central Government, SDLs issued by the State Governments also qualify for SLR(Statutory Liquidity Ratio).
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