Context: RBI is conducting ‘Operation Twist’ i.e. it will buy and sell government securities worth ₹10,000 crores each under its open market operations — a move aimed at managing the yields.
Prelims: Current events of national and international importance.
Mains: GS III-
- Indian Economy and issues relating to planning, mobilization of resources, growth, development, and employment. Inclusive growth and issues arising from it.
Why in News?
The Reserve Bank of India has conducted that it will carry out US-style 'Operation Twist' to bring down interest rates.
- RBI will conduct simultaneous purchase and sale of government securities under Open Market Operations (OMO) for ₹10,000 crores each.
- It will purchase the longer-term maturities (i.e government bonds maturing in 2029), and simultaneously sell the shorter duration ones (i.e. short-term bonds maturing in 2020).
- The eligible participants can bid or submit offers in electronic format on RBI’s Core Banking Solution (E-Kuber).
Why such a move?
Indian banks and NPAs
- NPA problem is such a big problem for Indian banks, especially PSBs.
- In March 2018, non-performing assets (NPAs) at commercial banks amounted to ₹10.3 trillion, or 11.2% of advances.
- Public sector banks (PSBs) accounted for ₹8.9 trillion, or 86%, of the total NPAs.
- The ratio of gross NPA to advances in PSBs was 14.6%.
- These are levels typically associated with a banking crisis.
RBI’S GOLDILOCKS CUT, ON REPO RATE CUT:
- The Reserve Bank of India (RBI) cut key interest rates for the fourth time this year as it strives to boost corporate investment and consumer spending to accelerate stubbornly slow economic growth,
- which it now expects will not exceed 6.9% in the current financial year, as both domestic and external demand stays weak.
- A cut of 35 basis points in the repurchase, or repo rate, at which the central bank lends funds to commercial banks took the cumulative reduction since February to 1.1 percentage point. One basis point is one-hundredth of a percentage point. The repo rate is now 5.15%, the lowest in nine years.
Change in growth projections:
- The RBI has sharply marked down the GDP growth projections for the current fiscal to 6.1%.
- This is down from the 6.9% that it had projected in the August policy.
- The downgrade was inevitable after the shocking 5% growth reported in the first quarter.
- However, even the revised estimate is a bit too optimistic.
- If the projection of 6.1% for 2019-20 is to be met, the economy has to grow by about 7% in the second half, which does not look very likely.
- Given this, the basis for RBI’s optimism appears unclear at this moment.
Reasons for Consecutive Rate Cuts by the Central Bank:
- RBI has been the most aggressive central bank in Asia in cutting interest rates this year to boost growth from a five- year low of 5.8% to which it sank in the quarter ended March and spur investments.
- Finance minister Nirmala Sitharaman had called for “significant” policy easing by the central bank to help revive growth, which slumped in the March quarter to a five-year low of 5.8%.
- The RBI said various high-frequency indicators suggest a weakening of both domestic and external demand conditions.
- Domestic economic activity continues to be weak. Private consumption, the mainstay of aggregate demand, and investment activity are sluggish.
- To address growth concerns, reducing the cost of capital is essential.
- The Business Expectations Index of the RBI’s industrial outlook survey showed muted expansion in demand conditions in the second quarter, although a decline in input costs augurs well for growth.
- Global slowdown is clear. There are escalating trade tensions, allegations about currency manipulations.
- When making an investment decision, it is this interest rate that matters. As a variable, it allows an investor to compare the attractiveness of different economies.
The above reasons clearly mandate that the RBI has to infuse more money to bring our economy on the track.
Why is it important?
- Despite a cumulative reduction of 135 basis points in India’s policy repo rate since January 2019, banks have effected a decline of just 40-47 basis points in their weighted average lending rates in the same period.
- Even the mandatory linking of bank lending rates to an external benchmark (including the repo rate) has not helped. With growing concerns over fiscal slippage and rising inflation, the key market interest rate that everyone tracks,
- the 10-year G-sec yield — rallied to 6.8 percent last week. Clearly, the MPC decision to pause repo rate cuts didn’t help, with a spike of 33 basis points coming in after the MPC meeting on December 5.
- High market yields on the 10-year G-sec influence bank lending rates on vehicle, housing and other long-term loans, hurting retail borrowers.
- This seems to have prompted the RBI to compensate for its unexpected pause on December 5 with the surprise announcement of Operation Twist.
- Though the amount of securities bought/sold on December 23 was only worth ₹10,000 crores, the bond markets still welcomed it with a big cheer. This was in anticipation of several such announcements in the future.
- Post the announcement, the 10-year G-sec yield dropped by 20 basis points on intra-day trade to 6.6 % while the yields on shorter tenure bond (five years) rose 16 basis points to 6.67 %, making for a flatter yield curve.
- That also helps bring down borrowing costs for the government.
- The name “Operation Twist” was given by the mainstream media due to the visual effect that the monetary policy action was expected to have on the shape of the yield curve.
- If we visualize a linear upward sloping yield curve, this monetary action effectively “twists” the ends of the yield curve, hence, the name Operation Twist.
- To put another way, the yield curve twists when short-term yields go up and long-term interest rates drop at the same time.
- This simultaneous purchase and sale will bring down interest on long term loans which can lead to an increase in economic spending.
- OMOs are primarily done to maintain ample liquidity in the system, which reflects that the RBI is keen that banks should transmit lower rates to borrowers.
- The action of Operation Twist by the RBI is encouraging for the market. This step may become a driving factor for long-term economic activity and the addition of new investment stock.
- It hopes that the Indian central bank might resort to measures like ‘Operation Twist’ to ease the long-term rates.
Open Market Operation:
The bottom line:
Santa may have arrived early for bondholders with Operation Twist. But if there’s an overshoot in the inflation and deficit numbers, you may need to watch out for other twists in this tale.