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What is Open Market Operations? Types

Open Market Operations:

The Reserve Bank of India (RBI) has decided to conduct simultaneous purchase and sale of government securities (G-Sec) under Open Market Operations (OMOs) for an amount of Rs. 10,000 crore each.

  • Simultaneous purchase and sale of government securities under OMOs, popularly known as operation twist, involves purchasing G-Sec of longer maturities and selling equal amounts of G-Sec of shorter maturities.

Open Market Operations:

  • Meaning: Open Market Operations refers to buying and selling of bonds issued by the Government in the open market.
  • One of the Quantitative Tools: OMO is one of the quantitative tools that RBI uses to smoothen the liquidity conditions through the year and minimize its impact on the interest rate and inflation rate levels.
  • Quantitative tools control the extent of money supply by changing the Cash Reserve Ratio (CRR), or bank rate or open market operations.
  • Qualitative tools include persuasion by the Central bank in order to make commercial banks discourage or encourage lending which is done through moral suasion, margin requirement, etc.

Impact on Money Supply:

  • When RBI buys a Government bond in the open market, it pays for it by giving a cheque. This cheque increases the total amount of reserves in the economy and thus increases the money supply.
  • Selling of a bond by RBI (to private individuals or institutions) leads to a reduction in the quantity of reserves and hence the money supply.

Two Types of OMOs: Outright and Repo.

  • Outright OMOs are permanent in nature: when the central bank buys these securities (thus injecting money into the system), it is without any promise to sell them later. Similarly, when the central bank sells these securities (thus withdrawing money from the system), it is without any promise to buy them.
  • Repo: This is a type of operation in which when the central bank buys the security, the agreement of purchase also has specifications about the date and price of the resale of this security. This type of agreement is called a repurchase agreement or repo. The interest rate at which the money is lent in this way is called the repo rate.
  • Similarly, instead of an outright sale of securities the central bank may sell the securities through an agreement that has a specification about the date and price at which it will be repurchased. This type of agreement is called a reverse repurchase agreement or reverse repo. The rate at which the money is withdrawn in this manner is called the reverse repo rate.
  • The Reserve Bank of India conducts repo and reverse repo operations at various maturities: overnight, 7-day, 14- day, etc.
  • These types of operations have now become the main tool of monetary policy of the Reserve Bank of India.

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