The RBI launched Operation twist on 19th December 2019 to lower long-term interest rates in the economy.
What is Operation twist by RBI?
Operation twist is buying and selling of Government securities by the RBI simultaneously through Open Market Operations (OMO). Basically, the RBI sells short-term securities and uses the proceeds to buy long term securities. Therefore, Operation Twist is also called Special Open Market Operations.
For the uninitiated, Open Market Operations is the buying and selling of Government securities by the RBI. If the RBI has to increase the money supply, it purchases government securities from the market. If the RBI has to decrease the money supply, it sells government securities in the market. [You may read: Repo, LAF, CRR, SLR, MSF, OMO, MSS- explained]
The first phase of Operation Twist was done on 19th December 2019. The RBI sold short-term securities (maturing in 2020) worth Rs.10000 crores and bought long-term securities (maturity period of 10 years) worth Rs.10000 crores. The latest round was done on 27th April 2020.
What is the purpose of Operation Twist?
The RBI buys long term Government securities. It increases the demand for long term securities, and hence its price. This, in turn, decreases the yield on these securities/ bonds.
The RBI sells short-term securities. It increases the supply for short term securities and hence reduces its price. This increases the yield on these securities/ bonds.
[Bond yield is the amount of return realised on a bond. There is an inverse relationship between bond price and bond yield. I highly recommend you to read this article- What is Bond, Bond Yield and Yield Curve?]
The interest rate in the economy is generally based on bond yields. The purpose of the operation is to decrease interest rates for long-term loans and boost lending and investment.
Why did the RBI launch Operation Twist when it has other tools at its disposal?
The RBI had to adopt this tool as it cut the Repo rate by 135 basis points last year. Even though RBI had cut rates, the banks haven’t didn’t pass it on to the borrowers. This was a step taken to drive up monetary policy transmission and lower the long-term interest rates.
[You may read- Why RBI did not cut interest rates in Dec 2019?]
Why is it called Operation ‘twist’ though?
The operation twist by the RBI is an Indian version of the monetary policy tool adopted by the Federal Reserve in the US in the aftermath of the Financial Crisis of 2008 to boost lending.
[The Fed implemented operation twist in 2011 and 2012. It ended the operation in December 2012 and replaced it with “quantitative easing”. [You may read: Quantitative Easing Explained] The original operation twist was launched in 1961. It was named after a dance move made popular by singer, Chubby Checker. ]
This monetary policy tool is called Twist (after the popular dance move) because it causes a twist in the shape of the yield curve. As the yield of short-term securities rises and that of long-term securities falls, the yield curve flattens. [You may read: What is a yield curve?]
[You may also read- What is Long-Term Repo Operations?]