Context

• 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 on December 23. 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.

Why Operation Twist now?

• The RBI slashed key interest rate — repo rate — by 135 points to 5.15 per cent this year but banks passed on only part of it.
• The one-year median marginal cost of funds based lending rate (MCLR) has declined only 49 basis points (bps). 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.
• The RBI says the decision follows “a review of the current liquidity and market situation and an assessment of the evolving financial conditions”.
• The central bank is keen that long-term rates are brought down to kickstart investment and revive the economy. The idea is that business investment and housing demand were primarily determined by longer-term interest rates.

What the RBI plans on December 23?

• The central bank has decided to purchase Rs 10,000 crore worth of one security — the 6.45 per cent GS 2029. This is a long term 10-year bond. On the sell side, it has proposed to sell four securities for a total of Rs 10,000 crore — 6.65 per cent GS 2020, 7.80 per cent GS 2020, 8.27 per cent GS 2020 and 8.12 per cent GS 2020. 
• All these four securities are short term, and maturing in 2020. When the RBI purchases 6.45 per cent bond on December 23, demand is expected to rise, leading to lower long-term yield. On the other hand, sale of short-term securities will push up the short-term rate.
• However, bankers say ‘Operation Twist’ is likely to put an end to the interest rate cut expectations. “It’s a signal of the RBI displeasure on Treasury Bill yield curve trending below the repo rate and its willingness to absorb the government’s supply at a time when the investors’ appetite is low in long duration,” said a banker.

The US experience.

• In 1961, the John F Kennedy administration proposed a solution to revive the weak economy through lower longer-term interest rates while keeping short-term interest rates unchanged — an initiative now known as ‘Operation Twist’ in homage to the Chubby Checker song and the dance then sweeping the nation.
• The US Fed employed the policy.
• The Fed then implemented the ‘Operation Twist’ programme in late 2011 and 2012 to stimulate the economy hit by the global financial crisis.
• The first programme was from September 2011 through June 2012 and involved the redeployment of $400 billion in Fed assets.
• The second ran from July 2012 through December 2012 and encompassed a total of $267 billion in response to continued sluggish growth in the US economy. In December 2012, the Fed ended the programme and replaced it with another policy of “quantitative easing”, which seeks to lower long-term rates by making open-market purchases of longer-dated Treasuries and mortgage-backed securities.

What are Open Market Operations?

• The RBI manages and controls the liquidity, rupee strength and monetary management through purchase and sale of government securities (G-Secs) in a monetary tool called Open market Operations. OMOs are the market operations conducted by the RBI by way of sale and purchase of G-Secs to and from the market with an objective to adjust the rupee liquidity conditions in the market on a durable basis.
• When the RBI feels that there is excess liquidity in the market, it resorts to sale of securities thereby sucking out the rupee liquidity.
• Similarly, when the liquidity conditions are tight, the RBI may buy securities from the market, thereby releasing liquidity into the market.
• The yield on 10-year benchmark bonds fell by 13 bps to 6.60 per cent, following the RBI announcement.

Source:IE