RBI decided to adopt Operation Twist after concerns on the current financial conditions of the country. The policy will be in line with Japan and USA monetary policy.
It is the first time that RBI is conducting open market operation because of an unsuccessful cut in policy rates by 135 basis points in February this year. RBI plans to buy and sell government securities of Rs 10,000 crore each. It has planned to purchase one long term bond worth Rs 10,000 crore (6.5%) of GS 2029. Also, it will sell four short-term securities maturing in 2020 of total worth Rs 10,000 crores.
What is Operation Twist?
The purchase of securities by RBI results in the rise of demand, increasing the price and decrease the yield as interest remains the same. Similarly, selling securities decreases prices and raises yields. The ‘Operation Twist’ is considered when despite lowering interest rates, the long term interest rate remains high.
Japan and USA
The first operation twist was carried in 1961, at the time of recession in the USA. The second was carried in 2011 to combat the financial crisis. Similarly, the Bank of Japan planned to buy government securities and extend its portfolio maturity to seven years in 2013.
What will Operation Twist do?
The concept of operation twist aims to decrease yields on 10-year government securities to drive down bank lending rates. The process would follow because investment in government securities is the safest and its yield sets a benchmark for other rates.
Many experts have raised suspicions on the effectiveness of the action. Sandeep Bagla, associate director at Trust Capital Services India said that since the central bank has limited influence on the longer end of the curve as it depends on inflation and fiscal conditions term, it may reduce the short-run steepness in interest rates. Also, the monetary policy committee headed by the governor, Shaktikanta Das, reduced repo rate to 5.15% due to inflation this month.
The action, if sustains, will not only decrease long term interest rate but will also increase the availability of cheap credit to boost the economy. In all, the government needs to unveil a road-map to fix the broken financial system. Only then such efforts will prove beneficial.