Home / News / India /  The relevance of OMO apparatus in RBI’s arsenal

Open market operations, or OMOs, are the purchase and sale of G-Secs by the Reserve Bank of India (RBI) on the Centre’s behalf to streamline money supply and interest rates. In case of excess liquidity in the market, RBI issues these securities via auctions, Mint explains.

How do OMOs impact money supply?

They are one of the three major monetary tools (besides reserve ratio and policy rates) to influence money supply in the market and achieve the desired trend in interest rate. There is an inverse relationship between bond prices and interest rates. Thus, purchase of bonds via an OMO raises the price of bonds and reduce rates. Open market purchases increase money supply, thus making money less valuable resulting in reduction of rates in the money market and vice versa. Monetary tools such as repo rate, reverse repo, marginal standing facility rate and bank rate are policy rates while CRR and SLR are the reserve ratios.

What are the main objectives of OMOs?

OMOs aim to control the supply of money or existing liquidity in the economy. In case of an inflationary situation, RBI adopts a contractionary monetary policy i.e., it sells government securities and absorbs the excess money from the financial flow. Amid a recessionary trend, RBI is keen to boost money supply in the market and ensure adequate credit availability for investment and production. So, it buys securities, increasing the money supply. RBI conducts OMOs via commercial banks and eligible participants are required to key in their bids on RBI’s core banking electronic solution platform E-Kuber.

Steering liqudity
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Steering liqudity

How do government securities function?

These are debt instruments issued by the RBI, on behalf of the government, for borrowing money. These could be treasury bills which are money market, short-term debt instruments or dated securities which are long-term instruments. Government securities are a promissory note with guaranteed payment at a zero-coupon rate and issued at a discounted rate.

What is the function of the bond market?

Bond prices and interest rates have a negative relationship as money supply and treasury bills move in different directions. When RBI hints at a surplus liquidity stance, short-term rates tend to go down and prices in money market rise, while, when RBI signals tightening of liquidity in the system, short-term rates surge and prices of money market instruments fall. With RBI lowering rates, investors locked in for long-term at higher returns stand to gain. In bond markets, rate expectations matter more than actual announcements.

How did bond market react post budget?

Banks, the biggest buyers of government bonds, prefer a falling interest rate. The fiscal deficit figures and the Centre’s borrowing plan announced on 1 February led to a surge in the yields for the 10-year bonds to 6.071% which eased to 6.031% on 8 February. RBI has maintained an accommodative stance on liquidity. On 8 February, it announced its plan to purchase bonds worth 20,000 crore via OMO, lending support to the Centre’s borrowing programme.

Jagadish Shettigar and Pooja Misra are faculty members at BIMTECH

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