RBI GRADE B PHASE 2 ESI FM STUDY MATERIAL 2020:A Special Open Market Operation
RBI GRADE B PHASE 2 ESI FM STUDY MATERIAL 2020
The Reserve Bank of India (RBI) conducted a special open market operation—simultaneously buying long-tenor bonds and selling short-tenor government bonds.It is the first time that the RBI has conducted a special open market operation (OMO) of this kind, similar to the 'Operation Twist' carried out in the United States near the start of the decade.
Reason of announcing such move-
This move announced to target term spreads or the difference between the 10-year bond yield and that of a one-year treasury bill.Such a move is aimed at reducing long-term interest rates and spur bank lending.
Reason of rising bond yields-
Sudden hardening of the US bond yields- US bond yields have increased by about 20 bps in the last couple of days and that had a profound negative impact on the sentiments of bond market participants.
Underperforming Rupee- On year to date basis, there is a 7?lta for Indian currencies performance against the dollar vis-à-vis the peers.
Increase in commodity prices- The recent increase in commodity prices, particularly oil, and its negative impact on economic growth and inflation.
Steps taken-
Sale and purchase of bonds- The Reserve Bank of India will conduct a simultaneous sale and purchase of bonds.It will buy 100 billion rupees' ($1.4 billion) worth of the current benchmark 10-year bond while selling four bonds maturing in 2020 for an equivalent amount.
Operation objectives- The simultaneous sale and purchase operation has a two-pronged objective which had dropped below the benchmark rate of 5.15%-
Lowering the steep term premium at the longer end of the yield curve despite the RBI’s accommodative monetary policy, and
Surplus systemic liquidity and correcting yields at the shorter end.
MPC decision- The central bank’s monetary policy committee (MPC) decided to keep rates on hold in December after lowering its repo rate by 135bps in five consecutive rate cuts between February and October.
Significance of the move-
Rising of demand- As RBI will buy long-term bonds, its demand will go up and yields will go down and the opposite will happen when it sells bonds. Through this, the central bank is narrowing out the differential between the short- and the long-term yields or smoothing the yield curve.
Cheaper borrowing money- As the long-term yields coming down, the government will be able to borrow money cheaper against its bonds, as well as induce demand for private sector loans.
Reducing interest burden- Long-term bond yields have fallen reducing the interest burden on the government. In short, it effectively makes long-term government borrowings cheaper.The 10-year bond yields have fallen by 15 basis points to 6.6 percent from 6.75 per cent.
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