The Reserve Bank of India has announced a simultaneous sale and purchase of government bonds under its open market operation programme, in a strategy akin to the ‘Operation Twist’ adopted in the United States as a way to influence bond yields.
The Indian central bank will buy long-term bonds, while simultaneously selling short-term government securities, it said in a release on Thursday. The decision will help bring down India’s long term-bond yields, which have been trading with a spread of 150 basis points over the RBI’s overnight repo rate. It will also push up short-term rates, which have been trading below the repo rate due to surplus liquidity conditions.
As per the release:
- RBI will purchase Rs 10,000 crore of 6.45 percent government bonds maturing in 2029.
- Simultaneously, RBI will sell Rs 10,000 crore of short-term bonds maturing in 2020.
The central bank said this was being done in light of the liquidity conditions and following an assessment of the evolving financial conditions. It gave no indication whether these would be continuing operations or a one-time signal to the market.
On a review of the current liquidity and market situation and an assessment of the evolving financial conditions, the Reserve Bank has decided to conduct simultaneous purchase and sale of government securities under Open Market Operations (OMO) for Rs 10,000 crores each on December 23, 2019.RBI Statement
WATCH | Implications of the RBI's version of 'operation twist' with Ananth Narayan and Arvind Chari.
RBI Wades Into Yield Management
The RBI’s decision to buy long term bonds and sell short term bonds is effectively a way to managing the yield curve.
India’s yield curve has remained steep with the ‘term premium’ for long term 10-year bonds at over 150 basis points above the overnight repo rate. This has not corrected even though liquidity has been in large surplus. ‘Term premium’ is effectively the additional interest that must be paid to borrow longer term money.
Fears of fiscal slippage and an increased supply has kept long term bond yields high. Last year, amidst tight liquidity conditions, the RBI had conducted large open market operations to purchase bonds, which helped keep yields in check and allowed the government’s borrowing program to go through smoothly.
This year, however, easy liquidity conditions have made it difficult to support bond yields via open market purchases.
To overcome that problem, the RBI has designed simultaneous sales and purchases of government bonds. The operation will be liquidity neutral but help in flattening the yield curve in India’s bond market.
While the purchase of long term bonds will pull down 10-year yields, the simultaneously sale of short term bonds could push up rates at the of shorter tenor bonds. Easy liquidity conditions have meant that short term government securities have seen a flush of money and a drop in interest rates.
In some cases, like the 91-day treasury bills, coupon rates have fallen below the policy rate of 5.15 percent, which is intended to act as a floor. The ‘operation twist’ could correct that anomaly as well.
“This ensures credibility of RBI’s policy rates and demonstrates the fact that liquidity operations are no longer a passive task,” said Soumyajit Niyogi, associate director at India Ratings and Research.
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