Open Market Operations by RBI Flashcards
NEWS
The Reserve Bank of India’s announcement on Friday (October 6) to consider the Open Market Operation (OMO) sale of government securities to manage liquidity in the system took the bond market by surprise as the central bank did not reveal any specific timeline for the proposal. In response, the yield on the benchmark 10-year government bonds shot up by 12 basis points to 7.34 per cent as the market anticipates an OMO shortly, which is expected to tighten liquidity in the system.
Key Point
Open Market Operations (OMOs) are market operations conducted by RBI by way of sale/purchase of government securities to/from the market with an objective to adjust the rupee liquidity conditions in the market on a durable basis.
If there is excess liquidity, RBI resorts to sale of securities and sucks out the rupee liquidity.
Similarly, when the liquidity conditions are tight, RBI buys securities from the market, thereby releasing liquidity into the market.
It is one of the quantitative (to regulate or control the total volume of money) monetary policy tools which is employed by the central bank of a country to control the money supply in the economy.
Long-term Repo Operations
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 prevailing repo rate.
As banks get long-term funds at lower rates, their cost of funds falls. In turn, they reduce interest rates for borrowers.
LTRO helps RBI to ensure that banks reduce their marginal cost of funds-based lending rate, without reducing policy rates.
Objectives of LTRO
To assure banks about the availability of durable liquidity at reasonable cost relative to prevailing market conditions.
Further encourage banks to undertake maturity transformation smoothly and seamlessly so as to augment credit flows to productive sectors.
Maturity transformation is when banks take short-term sources of finance, such as deposits from savers, and turn them into long-term borrowings, such as mortgages.
What’s OMO?
The RBI uses Open market operations (OMOs) in order to adjust the rupee liquidity conditions in the market on a durable basis. When the Reserve Bank feels that there is excess liquidity in the market, it resorts to the sale of government securities, thereby sucking out the rupee liquidity. Similarly, when the liquidity conditions are tight, the central bank buys securities from the market, thereby releasing liquidity into the market. It’s used as a tool to rein in inflation and money supply in the system. However, when liquidity is sucked out, it can lead to a spike in bond yields as the RBI will release more government securities into the market and bond buyers demand more interest rate on these securities.
Why RBI wants OMO?
While the specific OMO calendar has not been released, the RBI governor, in the post-policy press conference, emphasized the bank’s intent for “active liquidity management.” This signals the RBI’s inclination towards tighter liquidity conditions in the future, influenced by both inflation risks and financial stability concerns. This stance is in alignment with the central bank’s objective of anchoring inflation at 4 per cent. The RBI’s approach is clear: merely keeping inflation below the upper band of the target range (at 6 per cent) is insufficient, a more proactive approach is essential, according to Amnish Aggarwal, head of research at Prabhudas Lilladher Pvt Ltd.
What’s the liquidity position now?
The RBI governor hinted that the RBI could opt for an OMO sales auction of government securities to mop up any build-up of excess liquidity. The RBI has been conducting OMO sales in the secondary market over the past month, with net sales amounting to Rs 6,200 crore in September.
The RBI had implemented an incremental cash reserve ratio (I-CRR) in the August MPC meeting, resulting in the withdrawal of liquidity amounting to Rs 1.1 lakh crore from the banking system. Despite the gradual withdrawal of the I-CRR, systemic liquidity continued to stay in the deficit since mid-September due to quarterly tax outflows and GST payments. The advance tax payments have resulted in a rise in the government’s cash balance with the RBI, which is estimated at around Rs 2.7 lakh crore. A pickup in government spending in the second half and the withdrawal of I-CRR can increase systemic liquidity. However, a pickup in currency demand ahead of the festive season can counteract any increase in systemic liquidity, according to Care Ratings.
