Transfin.
HomeNewsGuidesReadsPodcastsTRANSFIN. EOD
  1. News
  2. Explained

RBI Announces Another Round of Operation Twist

Editor, TRANSFIN.
Aug 28, 2020 9:35 AM 3 min read
Editorial

The RBI released its Annual Report for 2019-20 yesterday. Many of the revelations were depressing.

The Central Bank pointed to a retrenchment of activity unprecedented in history, raised doubts over sustainability of upticks observed in May and June, and maintained that contraction would likely extend into the September quarter.

Plus there was an implicit indication that fiscal policy should take the lead in “pandemic-proofing” demand.

One would think this is the end of monetary policy interventions...right?

 

Wrong. There’s a Twist!

RBI negated any notion that monetary policy interventions are ending soon by simultaneously launching INR20,000cr of Open Market Operations (OMO) the very day i.e. Another  Operation Twist.

This is where the Central Bank buys long-term government securities, while selling short-term ones to push back or “twist” the yield curve into normalcy.

The phrase “Operation Twist” has delightfully interesting roots. This monetary tool was first used in the US during the Kennedy administration. And it was named so after the iconic Chubby Checker song “The Twist” that the country was grooving to in 1961.

 

Now That We Have Your Undivided Attention

One of the main duties of the RBI is to maintain liquidity in the system. One way it does this is through OMOs like Operation Twist. So what exactly happens in Operation Twist?

 

Hit Rewind

In December 2019, the RBI was faced with a conundrum. It had slashed the repo rate by 135 bps down to 5.15%, but banks were not transferring this onto consumers - the lending rate had fallen by only 49 bps during the corresponding period.

The Central Bank wanted to make borrowing easier because that would lead to more spending, more economic activity and thus more growth. (Flashback: the country was experiencing a prolonged slowdown before COVID-19 struck.)

So what did the RBI do? It stepped in to make lending easier via OMOs. For this to happen, it sought to bring down long-term Government bond yields...because these act as an interest-rate benchmark for auto loans, home loans, or for that matter any long-term investments or borrowing.

So, the logic was: bring down long-term bond yields = loans will become cheaper.

But this is tricky. Because as anyone who knows bond basics would tell you (and read this article to know the basics), bond prices and yields are inversely related.

That means long-term bond yields are higher than short-term bond yields. Which is logical, because if you’re investing your money in an instrument for a longer period of time, you’ll expect the returns to be relatively higher than if you invested the same money in a short-term instrument.

So, the RBI had to bring long-term bond yields down...below short-term bond yields. Now that’s also not done. Right?

 

Enter Operation Twist

This is basically a set of two simultaneous transactions between the RBI and the Government:

  1. The Central Bank buys long-term Government bonds = demand for these bonds goes up = yield falls down.
  2. The Central Bank sells short-term Government bonds = demand for these bonds goes down = yield climbs up.

It’s a fairly simple transaction once you understand the logic of it.

 

So What’s Happening Now?

Yesterday, the RBI announced another round of Operation Twist to be conducted on August 27th and September 3rd. An aggregate amount of ₹20,000cr of Government securities will be swapped in two tranches of ₹10,000cr each.

The instruments that will be bought include 4-year, 7-year, 10-year and 12-year Government securities. Meanwhile, short-term papers maturing in 2020 will be sold.

 

What’s the Expected Outcome?

The expectation is that another Operation Twist will bring down interest rates, boost borrowing, increase consumption and stimulate economic activity at a time when the economy is limping.

This also signals that the RBI will stay in intervention mode, irrespective of the fiscal policy lip-service put in its report.

In any case, we’ll lose track of all of this by the weekend considering the eventful times we’re living in!

FIN.

There's so much happening around that simply keeping up can be a task! How about fun Quizzes to help you retain? Subscribe to our Quiz Knock Newsletter to receive them straight to your inbox.