Liquidity infusion by RBI

Subject: Economy

Context:

• The Reserve Bank of India (RBI) has announced measures, including two more tranches of ‘Operation Twist’ aggregating Rs 20,000 crore and term repo operations aggregating Rs 1 lakh crore in September
• RBI has also decided to allow banks to hold fresh acquisitions of statutory liquidity ratio (SLR) securities acquired from September 1, 2020, under Held-To-Maturity (HTM) up to an overall limit of 22 per cent of net demand and time liabilities (NDTL) up to March 31, 2021

Concept:

Operation Twist

• The tool essentially aims at changing the shape of the yield curve (hence the name — twist) through simultaneous buying and selling of long- and short-term government bonds.
• In India, at first, the RBI put through its version of Operation Twist by buying ₹10,000 crore worth of 10-year government bonds while selling four shorter-term government bonds adding up to the same value.
• The intent is to moderate high long-term interest rates in the market and bring them closer to the repo rate.
• History of Operation Twist: In 1961, the John F Kennedy administration proposed a solution to revive the weak economy through lower longer-term interest rates while keeping short-term interest rates unchanged. This initiative is now known as ‘Operation Twist’ which was employed by the US Fed.

Yield Curve:

• A yield curve is a graph of interest rate on all government bonds ranging from the short-term debt (one month) to long-term debt (could be high as 30 years).
• Typically, the short term bond has lower interest rate compared with the long-term bond reflecting the higher perceived risk of the latter. Hence a graph of the interest rate of the short-term bond and longer-term will be an increasing line chart. This in technical parlance is called an upward sloping curve.

Term repo operations

• The LTRO is a tool under which the central bank provides one-year to three-year money to banks at the prevailing repo rate, accepting government securities with matching or higher tenure as the collateral.
• While the RBI’s current windows of liquidity adjustment facility (LAF) and marginal standing facility (MSF) offer banks money for their immediate needs ranging from 1-28 days, the LTRO supplies them with liquidity for their 1- to 3-year needs.
• LTRO operations are intended to prevent short-term interest rates in the market from drifting a long way away from the repo rate.

Statutory liquidity ratio (SLR)

• Apart from Cash Reserve Ratio (CRR), banks have to maintain a stipulated proportion of their net demand and time liabilities in the form of liquid assets like cash, gold and unencumbered securities.
• Treasury bills, dated securities issued under market borrowing programme and market stabilisation schemes (MSS), etc also form part of the SLR.
• Banks have to report to the RBI every alternate Friday their SLR maintenance, and pay penalties for failing to maintain SLR as mandated.