Why in news?
The Reserve Bank of India (RBI) has announced simultaneous purchase and sale of government bonds in a bid to soften long-term yields.
The central bank will buy ₹10,000 crore of bonds maturing between 2026 and 2030 and sell the same number of T-bills.
- On a review of current and evolving liquidity and market conditions, the Reserve Bank has decided to conduct simultaneous purchase and sale of government securities under open market operations (OMO) for ₹10,000 crore each on April 27, 2020.
- Such open market operations are known as ‘Operation Twist,’ which was used by the RBI in December 2018 for the first time.
- Following the announcement, the yields on the 10- year bonds dropped by 20 basis points (bps).
- The move will also aid monetary transmission by prompting banks to pass on interest rate cut benefits to their customers.
- The RBI had reduced key policy rate or the repo rate by 75 bps to 4.4% in the monetary policy review, announced in the last week of March 2020.
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.
- 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.
- ‘Operation Twist’ is when the central bank uses the proceeds from sale of short-term securities to buy long-term government debt papers, leading to easing of interest rates on the long term papers.
- The name “Operation Twist” was given by the mainstream media due to the visual effect that the monetary policy action was expected to have on the shape of the yield curve.
- If we visualize a linear upward sloping yield curve, this monetary action effectively “twists” the ends of the yield curve, hence, the name Operation Twist.
- To put another way, the yield curve twists when short-term yields go up and long-term interest rates drop at the same time.
- This is expected to lead to a flattening of the yield curve. Long-end rates are expected to come off, while short-term rates could rise