RBI will use OMOs to ensure liquidity

October 1, 2013

Giving assurance to the markets, the Reserve Bank of India said that it will take actions, including Open Market Operations (OMOs), to ensure adequate liquidity in the system. The central bank’s assurance follows hardening of yields on government securities after governor Raghuram Rajan raised the repo rate by 25 basis points to 7.50%.

Why there is hardening in yield on government securities/bonds?

The hardening of yields in the government securities market is due to uncertainties around the government borrowing programme for the second half of 2013-14 as well as the prospective effects of banks’ half-yearly account closure, the seasonal pick-up in credit demand, festival-related demand and sluggish deposit growth. There is sudden spike in the yield on the 10-year benchmark government bond which is making the RBI uncomfortable.

What are Open Market Operations (OMOs)?

Open Market Operations (OMOs) refers to the purchase and sale of the Government securities by the Reserve bank of India from / to public on its account. But in India, as of now the market for government securities is not well developed, still OMO plays very important role.
Here is how OMO works:

When RBI sells government security in the markets, the banks purchase them.
When the banks purchase Government securities, they have a reduced ability to lend to the industrial houses or other commercial sectors.
This reduced surplus cash, contracts the Credit supply.
When RBI purchases the securities, the commercial banks find them with more surplus cash and this would create more credit in the system.

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