Open Market Operations (OMO)
Context:
The Reserve Bank of India (RBI) recently announced fresh measures to inject ₹2.90 lakh crore of liquidity into the banking system.
This includes Open Market Operation (OMO) purchase auctions of Government Securities (G-Secs) worth ₹2,00,000 crore.
Alongside OMOs, the RBI is conducting a Buy/Sell swap (buying USD now to sell later worth $10 billion) to infuse rupee liquidity while managing excess dollar liquidity in the system.
Basics of OMO
It is the process by which the central bank purchases or sells government securities (G-Secs) or other financial assets to/from banks and financial institutions.
The objective is to adjust the supply of primary liquidity (base money) in the economy, thereby influencing the total money stock and interest rates.
Purchase of G-Secs injects liquidity (increases money supply).
Saleof G-Secs absorbs liquidity (decreases money supply).
Types of OMO:
Permanent OMO:
It involves the permanent buying or selling of securities without any promise of resale or repurchase.
It is used for managing durable liquidity needs.
When RBI buys securities outright, it permanently adds funds to the banking system's reserves.
Repurchase Agreement:
It is a transaction where securities are exchanged for cash with an agreement to reverse the transaction (repurchase/resell) at a specific future date and price.
It is typically used for managing short-term or frictional liquidity mismatches.
It acts as a collateralized loan where the central bank injects funds for a short period against G-Sec collateral.
Instruments used in OMO’s:
Treasury Bills (T-Bills)
Government of India Bonds
Special Open Market Operations (S-OMO)
Impact of OMO on Economy:
On Interest Rates: By injecting or absorbing liquidity, the RBI influences short-term interest rates.
In general, higher liquidity in the system corresponds to lower short-term interest rates, while reduced liquidity corresponds to higher rates.
On Stock Markets: Equity markets react to liquidity easing through lower interest rates affecting borrowing, consumption, and corporate profits.
On Bond Markets: RBI purchases of government securities raise bond prices due to demand, lowering yields.
On Exchange Rates: Excess liquidity is associated with rupee depreciation. OMOs address this.