People mistake Operation Twist for a military operation. Well, it’s not. The word appeared in the US, way back in 1961. Operation Twist was a way to strengthen the US Dollar and stimulate cash flow in the economy. The Federal Reserve (Our version of the RBI) bought and sold Government Bonds to offer monetary easing in the economy. This helps boost the economy and stock prices rise.
The Reserve Bank of India will conduct a simultaneous sale and purchase of bonds. This move will bring long term bond yields lower. This could stimulate growth and bring the economy back on track. (With a GDP of 4.5% in the second quarter of FY20, something had to be done). This is the first time RBI is conducting this type of open market operation.
An open market operation is the sale or purchase of Government Bonds and Treasury Bills by the RBI to regulate money supply in the economy. If RBI wants to increase the money supply in the economy it purchases Government Securities. If RBI wants to decrease the money supply in the economy it sells Government Securities. This is done through commercial banks. The open market operations smoothen liquidity conditions and minimize the impact of interest and inflation.
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The RBI will buy Government Securities worth Rs 10,000 crores with a 10-year maturity. At the same time RBI will sell Government Bonds with a 1-year maturity worth Rs 10,000 crores. This would be done on December 23rd 2019.
RBI will purchase Rs 10,000 crores worth of the GS 2029 offering 6.45%. It will simultaneously sell GS 2020 offering 6.65%, GS 2020 offering 7.8%, GS 2020 offering 8.27% and GS 2020 offering 8.12%.
RBI has cut repo rate this year by a total of 135 basis points. However, the yield on the 10-year G-Sec has come down by just 80 bps. The 10-year G-Sec was 7.55% in February 2019. It has come down to 6.75% in December 2019. The 10-year G-Sec is considered the risk free rate in India. It’s currently around 6.6%.
If the Government has to boost the economy, the long term interest rates must fall. So, RBI buys long term securities like GS 2029 increasing demand for them. As more money flows into the GS 2029, its interest rates come down. (Yields Fall). The Government is also simultaneously selling the GS 2020 reducing demand for them. The interest rates rise. So, the yield curve gets twisted as short term rates rise and long term rates fall. This is why it’s called operation twist.
The Government will buy the 6.45% GS 2029 which closed at 6.75%. This bond was trading at 6.61% which shows the interest falling as an immediate impact of this decision. But, would this sustain in the long run?
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