What is it?
- Operation Twist is an initiative of the RBI that aims to control long-term bond yields and bring down interest rates on long-term borrowing.
- It is a monetary policy intervention by the central bank, conducted through Open Market Operations (OMOs), where the central bank is buying long term government securities and at the same time selling short term government securities.
- Buying long term securities and selling short term securities will reduce the yield of long term securities. This yield impact is the objective of Operation Twist.
- Yield is the return an investor gets on his bond.
Rationale behind Operation Twist
- Whenever there is a long-term investment deficit in the country and the investors are hesitant to make long-term investments in the economy, the government or the central bank jumps in to revive growth by lowering the interest rate for long-term investment ventures.
- As the central bank buys long-term securities (bonds), their demand rises which in turn pushes up their prices.
- However, the bond yield comes down with an increase in prices, because there is an inverse relationship between the bond prices and their yields.
How will it affect the economy?
- The interest rate in an economy is determined by yield. Thus, lower longer-term yields reduces long-term interest rates, which means people can avail long-term loans (such as buying houses, cars or financing projects) at lower rates.
- This also results in a dip in the expected returns from long-term savings which tilts the balance from saving towards spending.
- Hence, cheaper retail loans can help encourage consumption spending which is the largest GDP component in the economy.
Why in News?
- The RBI has announced to restart Operation Twist to soften long-term yields on July 2.
- The RBI will purchase longer tenure government bonds that are maturing in 2027, 2029, 2031 and 2033, while selling four securities of shorter maturity.
- Operation Twist was used by the RBI in December last year for the first time.
What are Open Market Operations (OMOs)?
- Open Market Operations are conducted by the RBI which involves sale or purchase of G-Secs to or from the market. The objective is to control the money supply conditions.
- If there is excess money supply (i.e. excess liquidity) in the market, the RBI resorts to sale of securities which reduces the volume of money. Similarly, when the liquidity conditions are tight, it buys securities from the market, thereby releasing money into the market.
What are Government Securities (G-Secs)?
- G-Secs are tradable instruments like bonds issued by the Central Government or the State Governments with a promise of repayment upon maturity.
- The Central Government can issue both treasury bills and bonds while the State Governments can issue only bonds, which are called the State Development Loans (SDLs).
- These securities are considered low-risk, since they involve the government and hence, are called risk-free gilt-edged instruments.