Monetary policy operations

  • October 24, 2022
  • Posted by: OptimizeIAS Team
  • Category: DPN Topics
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Monetary policy operations

Subject :Economy

Context:

There could be changes, both in technical settings as well as the overall operating framework of monetary policy operations.

Monetary policy trends:

  • Traditional/normal times–
    • Open Market Operations with the stated objectives to manage liquidity and indirect impact on yield curve.
    • At the same time, specific frictions in other markets are managed through operations such as LTROs
  • Pandemic—forward guidance on an accommodative stance due to lower growth prospects.
    • Direct quantitative easing– Government Securities Acquisition Programme (GSAP 1) in April 2021.
    • However, as inflation started to rise along economic recovery, the RBI curtailed the same.
  • Post Pandemic Cost Push inflation
    • Forward guidance–Withdrawal of accommodation and aligning inflation outcome closer to the target.

Issues in monetary policy operation—as the global economy enters a new era of higher inflation with potentially lower trend line growth.

  • Management of surplus liquidity– Liquidity management operations are required to ensure the operating target is aligned to MPC’s policy rate.
  • Monetary-fiscal conflict–Market stabilisation scheme (MSS) remains essential to deal with surplus liquidity which is in conflict with the cheaper borrowing rate– the operating policy stance as determined by the repo rate.
    • Market Stabilization scheme (MSS) is a monetary policy intervention by the RBI to withdraw excess liquidity (or money supply) by selling government securities in the economy.
    • The MSS was introduced in April 2004 to withdraw huge liquidity in the economy as a result of RBI buying large amounts of foreign currencies.

Concept:

Open market operations in Details:

  • They are one of the three major monetary tools (besides reserve ratio and policy rates) to influence money supply in the market and achieve the desired trend in interest rate.
    • Monetary tools such as repo rate, reverse repo, marginal standing facility rate and bank rate are policy rates while
    • CRR and SLR are the reserve ratios.
  • OMOs are  the purchase and sale of G-Secs by the RBI on the Centre’s behalf to streamline money supply and interest rates.
    • Government securities are debt instruments issued by the RBI, on behalf of the government, for borrowing money. These could be treasury bills which are money market, short-term debt instruments or dated securities which are long-term instruments. Government securities are a promissory note with guaranteed payment at a zero-coupon rate and issued at a discounted rate.
  • RBI conducts OMOs via commercial banks and eligible participants are required to key in their bids on RBI’s core banking electronic solution platform E-Kuber.

What are the main objectives of OMOs?

OMOs aim to control the supply of money or existing liquidity in the economy.

  • In case of an inflationary situation, RBI adopts a contractionary monetary policy i.e., it sells government securities and absorbs the excess money from the financial flow.
  •  Amid a recessionary trend, RBI is keen to boost money supply in the market and ensure adequate credit availability for investment and production. So, it buys securities, increasing the money supply.

What is the function of the bond market?

  • Bond prices and interest rates have a negative relationship as money supply and treasury bills move in different directions.
    • Thus, purchase of bonds via an OMO raises the price of bonds and reduces rates.
  • Open market purchases increase money supply, thus making money less valuable resulting in reduction of rates in the money market and vice versa.
  • When the RBI hints at a surplus liquidity stance, short-term rates tend to go down and prices in the money market rise, while, when RBI signals tightening of liquidity in the system, short-term rates surge and prices of money market instruments fall.

The G-Sec Acquisition Programme (G-SAP)

  • It is an unconditional and a structured Open Market Operation (OMO), of a much larger scale and size.
  • The word ‘unconditional’ here connotes that RBI has committed upfront that it will buy G-Secs irrespective of the market sentiment.
  • Objective: To achieve a stable and orderly evolution of the yield curve along with management of liquidity in the economy.
  • By purchasing G-secs, the RBI infuses money supply into the economy which inturn keeps the yield down and lower the borrowing cost of the Government.
economy Monetary policy operations