What is Open Market Operations (OMOs)?
Historical Background
Key Points
8 points- 1.
Mechanism: RBI buys or sells government bonds and treasury bills from/to commercial banks and other financial institutions.
- 2.
Liquidity Injection: When RBI buys G-Secs, it pays cash to commercial banks, increasing their reserves and injecting liquidity into the system, which can lower short-term interest rates.
- 3.
Liquidity Absorption: When RBI sells G-Secs, commercial banks pay cash to RBI, reducing their reserves and absorbing liquidity from the system, which can raise short-term interest rates.
- 4.
Impact on Interest Rates: Injection of liquidity tends to lower short-term interest ratesthe cost of borrowing money for short periods, making credit cheaper and encouraging lending. Absorption tends to raise them.
- 5.
Types: Can be outright purchases/sales (permanent in nature) or repo/reverse repo operations (temporary, under Liquidity Adjustment Facility (LAF)). The current news refers to outright purchases.
- 6.
Objective: To influence credit conditions, money supply, inflation, and ultimately economic growth by managing the availability of funds in the banking system.
- 7.
Flexibility: OMOs are a flexible tool as the RBI can conduct them frequently and in varying sizes to respond to evolving liquidity conditions.
- 8.
Market Impact: Affects the demand and supply of government securities, influencing their prices and yields.
Visual Insights
Open Market Operations (OMOs) vs. Liquidity Adjustment Facility (LAF)
This table compares Outright Open Market Operations (OMOs) with Liquidity Adjustment Facility (LAF) operations (Repo/Reverse Repo), highlighting their distinct characteristics and roles in RBI's liquidity management.
| Feature | Outright Open Market Operations (OMOs) | Liquidity Adjustment Facility (LAF) Operations (Repo/Reverse Repo) |
|---|---|---|
| Nature of Operation | Permanent injection or absorption of liquidity. | Temporary injection (Repo) or absorption (Reverse Repo) of liquidity. |
| Duration | Long-term impact on liquidity; changes the base money supply permanently. | Short-term (typically overnight to 14 days) impact on liquidity; temporary adjustment. |
| Objective | To manage structural or durable liquidity in the system; influence long-term interest rates. | To manage day-to-day, frictional liquidity mismatches in the banking system; influence short-term interest rates (call money rate). |
| Mechanism | RBI directly buys (injects) or sells (absorbs) government securities from/to the market. | Banks borrow from RBI (Repo) or lend to RBI (Reverse Repo) against collateral of government securities. |
| Collateral | No collateral involved in the transaction itself (outright sale/purchase). | Government securities are used as collateral for borrowing/lending. |
| Impact on RBI's Balance Sheet | Changes the size of RBI's balance sheet (permanent change in assets/liabilities). | Does not permanently change the size of RBI's balance sheet (temporary change). |
| Frequency | Conducted less frequently, usually to address persistent liquidity conditions. | Conducted daily or frequently (e.g., variable rate auctions) to fine-tune liquidity. |
Recent Developments
4 developmentsIncreased use of OMOs during periods of economic stress (e.g., COVID-19 pandemic) to ensure adequate liquidity and support government borrowing.
Introduction of Operation Twist simultaneous buying of long-term G-Secs and selling of short-term G-Secs to manage the yield curve and influence long-term interest rates.
Implementation of G-Sec Acquisition Programme (GSAP) during 2020-21 to provide liquidity and support the government's borrowing program in a transparent manner.
Coordination of OMOs with other liquidity management tools to achieve desired monetary policy outcomes.