From UPSC perspective, the following things are important :
Prelims level : OMO
Mains level : OMO - effectiveness
The Reserve Bank of India announced its decision to conduct simultaneous purchase and sale of government securities for Rs 10,000 crore each, under Open Market Operations (OMO).
The need of the hour
- This is done after a review of the current liquidity, market situation and evolving financial conditions.
- Similar to past US experiments – Financial markets perceive this as an Indian variant of Operation Twist. This is said to be similar to the asset purchase programme kicked off by the Kennedy administration in the US in 1961 and later in 2011 by the US Federal Reserve to help lower long-term interest rates.
- It is an instrument of monetary policy aimed at either withdrawing liquidity or boosting it, including during periods of robust capital flows.
- Objective – The aim is to influence long-term interest rates and also to provide a boost to the economy by making the cost of capital or funds cheaper for business and industry and other borrowers.
- Such programmes were launched in the US first during a recession and later during a prolonged slowdown.
- Reason – Even after aggressively cutting its policy rate by 135 basis points this year, monetary policy transmission has been weak. Banks are not lowering rates significantly given the state of their balance sheets.
- Need for complementary support – for such a programme to have an impact, there should be a well functioning market for government securities with depth.
- Poor financial sector – the link between India’s bond market and the real economy has been relatively weak and making it worse is a half functional financial sector now.
- Fiscal performance – the large fiscal slippage — the fiscal deficit at the end of April-October this year at above 100% of the budgeted target — the spike in inflation and toned down projections of GDP growth.
- Lessons from the US experience – a programme aimed at reducing long-term bond yields will only have limited impact as long as the government runs a large deficit.
- There is a growing recognition that central banks are running out of ammunition.
- The government should get to work on a credible fiscal deficit reduction plan.
- It should fix the broken financial system along with unveiling a roadmap for state-owned banks.
- The divestment programme should get going.
- The packages for sectoral issues, especially real estate, should be operationalised swiftly.
Open Market Operations