RBI’s Operation Twist: methodology (2019-Dec) Flashcards
What is Operation Twist?
A type of Open Market Operation (OMO) conducted by the RBI. Involves the simultaneous buying and selling of government securities (G-Secs) with different maturities. Aims to influence long-term interest rates and promote economic growth.
Why did the RBI implement Operation Twist in 2019?
Traditional monetary policy tools weren’t effectively lowering borrowing costs for businesses. The goal was to stimulate the economy by making it cheaper for companies to invest.
Explain the core mechanism of how Operation Twist works.
RBI buys long-term G-Secs. Increased demand raises G-Sec prices and lowers their yields. Corporate bond prices are benchmarked against G-Sec yields, so corporate borrowing costs decrease. Banks are pressured to lower interest rates to remain competitive.
What are the key objectives of Operation Twist?
Reduce borrowing costs for companies and the government. Stimulate investment and economic growth. Improve the transmission of monetary policy changes into actual lending rates.
Is Operation Twist designed to combat inflation?
No. The primary focus of Operation Twist is to enhance economic growth by making borrowing more affordable. It is not a direct tool for controlling inflation.
How does Operation Twist potentially boost consumption in the economy?
Investors holding long-term G-Secs may be tempted to sell them before maturity when yields fall. This freed-up capital can be invested in other assets like corporate bonds, real estate, or go towards consumer spending. Increased consumption can stimulate economic activity.
What is the historical context of Operation Twist?
The strategy was pioneered by the US Federal Reserve in 1961. RBI adopted a similar approach in 2019 with specific adjustments for the Indian economic context.
What does it mean when we say Operation Twist improves “monetary policy transmission”?
Traditional monetary tools (like changing repo rates) don’t always translate directly into lower real-world borrowing costs for businesses. Operation Twist helps bridge this gap by directly influencing long-term interest rates, making monetary policy changes more effective in stimulating the economy.
Can you name a potential limitation of Operation Twist?
Its effectiveness depends on market conditions and investor behavior. If investors are reluctant to shift away from G-Secs, the impact on long-term interest rates could be limited.
How might Operation Twist impact the government’s own borrowing costs?
By lowering long-term interest rates, Operation Twist can also reduce the cost for the government to borrow money through issuing long-term bonds.
