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RBI’s Operation Twist – All You Need to Know

28 Nov 2022 0 COMMENT

Introduction

If you’re a keen observer of national and international financial developments, you must have heard about the term Operation Twist. It refers to an unconventional monetary policy adopted by several central banks across the world to control interest rates, inflation, and investments in their countries.

In India, the Reserve Bank of India (RBI) tried Operation Twist in 2019 and 2020 to revive the continuing economic slowdown. If you want to know more about this policy, you’re on the right page. In this blog, we will discuss in detail what operation twist is, how it works, and why it was carried out by the RBI.

What is Operation Twist?

Operation Twist is a monetary policy of the central banks used to bring down interest rates and control investments in a country. RBI deployed this policy in India in 2019 and 2020. Under this operation, the RBI twisted the yield of government securities to bring liquidity into the markets.

This is done by simultaneous buying and selling government securities—both short-term and long-term—through Open Market Operations (OMOs). Operation Twist was first used by the United States Federal Reserves in 1961 to stimulate the US economy. The mechanism worked by reviving the US Economy through increased short-term rates.

The US Federal Reserve again used Operation Twist in 2011 to augment the economic growth in the country after a global financial crisis.

How does Operation Twist work?

The prices of securities and yields provided by them are inversely proportional to each other. It means that when the price of a security goes up, its yield automatically decreases. Moreover, the prices of securities depend greatly on the demand-supply factor.

So, when the RBI wants to increase the prices of government securities, it buys and holds them. This, in turn, increases their demand and lowers the supply, causing their prices to rise. Subsequently, their yields come down. Similarly, when RBI decides to decrease the prices of government securities, it starts selling them. This increases their supply in the market, causing the prices to decline and yields to rise.

This entire exercise creates a twist in the yield curve of securities and impacts the liquidity in the markets. It can also affect the interest rates for loans and fixed-income generating instruments.

Why did the RBI deploy Operation Twist?

The Reserve Bank of India (RBI) deployed Operation Twist in several phases across 2019 and 2020. The first phase of this operation was carried out in December 2019 to control the long-term yield of government securities and bring liquidity into the markets. The RBI sold short-term bonds worth Rs 6,825 crore to buy long-term bonds with a maturity of 10 years or more.

In the second phase, the RBI again sold short-term bonds worth Rs 8,501 crore in August 2020 to buy long-term bonds. In the third phase, the RBI bought long-term government securities. This whole exercise was done to revive the slowing economy by twisting the interest rates or yields and attracting investments from domestic investors.

How did Operation Twist impact long-term investors?

After the completion of the three phases of Operation Twist, the long-term bond yields came down. As a result, the interest rates also fell, and the corporates were able to borrow money at lower costs. This helped in bringing liquidity to the financial and investment markets.

Investors use long-term bond yields to compute risk-free return rates. Then, they compare these rates with their equity investments to determine the success rate of their returns. When long-term yields come down, the value of stocks also decreases. This, in turn, attracts a larger number of investors to invest in the markets.

Why is Operation Twist more impactful than conventional rate cuts?

After learning everything about Operation Twist, you might be thinking, what was the need for RBI to take a complex approach when they could have simply changed the repo rate? Let us tell you that conventional rate cuts are not as effective as RBI’s Operation Twist because the banks may or may not pass the rate cuts to investors.

That is why RBI used Operation Twist as an effective mechanism to revive the slowing economy and boost investments in stock markets and government securities. Operation Twist was ultimately meant to help all three parties—government, corporates, and investors. In fact, it’s one of the reasons why the Indian economy continued surging despite the COVID-19 pandemic.

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