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RBI’s Open Market Operation (OMO) plan
Context
The Reserve Bank of India (RBI) has recently announced to potentially conduct OMO sales of government securities which impact the bond market, causing a 12 basis points rise in the 10-year bond yield to 7.34%.
About the move:
- As, the Retail inflation at 83% in August surprised the market.
- RBI may conduct OMO sales to control liquidity, given cash withdrawals during the festival season.
What is Open Market Operation (OMO)?
- Open market operations are conducted by the RBI by way of sale or purchase of government securities (g-secs) to adjust money supply conditions.
- The central bank sells G-secs to suck out liquidity from the system and buys back g-secs to infuse liquidity into the system.
- These operations are often conducted on a day-to-day basis in a manner that balances inflation while helping banks continue to lend.
- The RBI uses OMO along with other monetary policy tools such as repo rate, cash reserve ratio and statutory liquidity ratio to adjust the quantum and price of money in the system.
- The Reserve Bank reserves the right to decide-
- on the quantum of purchase/sale of individual securities
- accept bids/offers for less than the aggregate amount
- purchase/sell marginally higher/lower than the aggregate amount due to rounding-off
- accept or reject any or all the bid/offers either wholly or partially without assigning any reasons.
Impact on Money Supply:
- When RBI buys a Government bond in the open market, it pays for it by giving a cheque. This cheque increases the total amount of reserves in the economy and thus increases the money supply.
- Selling of a bond by RBI (to private individuals or institutions) leads to reduction in quantity of reserves and hence the money supply.
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Government Securities (G-sec):
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Importance of OMO:
- In India, liquidity conditions usually tighten during the second half of the financial year (mid-October onwards).
- This happens because the pace of government expenditure usually slows down, even as the onset of the festival season leads to a seasonal spike in currency demand.
- Moreover, activities of foreign institutional investors, advance tax payments, etc. also cause an ebb and flow of liquidity.
- However, the RBI smoothens the availability of money through the year to make sure that liquidity conditions don’t impact the ideal level of interest rates it would like to maintain in the economy.
- Liquidity management: Liquidity management is also essential so that banks and their borrowers don’t face a cash crunch.
- The RBI buys G-Secs if it thinks systemic liquidity needs a boost and offloads them if it wants to mop up excess money.
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