Open Market Operations

The Reserve Bank has several ways to change how much rupee money is sloshing around the banking system. Open Market Operations (OMOs) are the ones that use the bond market.

The workbook defines them as market operations conducted by the RBI by way of sale or purchase of G-Secs to or from the market, with an objective to adjust the rupee liquidity conditions in the market on a durable basis.

The mechanics are intuitive once you follow the money:

• When RBI sells a government security, buyers pay RBI with rupees. Those rupees leave the system. RBI does this when it feels there is excess liquidity — it sucks out rupee liquidity.
• When RBI buys a government security, it pays sellers in rupees. Money enters the system. RBI does this when liquidity conditions are tight — it releases liquidity.

The words "on a durable basis" are the point. OMOs change the stock of liquidity for the longer haul, rather than smoothing one day's shortage.

Where OMOs sit among RBI's tools. In the workbook's discussion of what determines interest rates, the central bank uses repo and reverse repo with commercial banks to control the short-term rate — repo to inject liquidity into the money market, reverse repo to drain it. To influence the long-term rate it uses the bank rate, cash reserve ratio, statutory liquidity ratio and open market operations. The money market section adds that RBI uses the money market to transmit monetary policy by changing reserve ratios, conducting OMOs, and moving policy rates.

Who carries them out. RBI introduced the Primary Dealer system in 1995, and one of its stated objectives is to make PDs an effective conduit for open market operations. RBI also absorbs or supplies overnight liquidity through banks and Primary Dealers.

Not to be confused with its neighbours in the same section:

Illustrative amounts and prices.

Tight liquidity — RBI buys. Banks are short of rupee funds. RBI announces an OMO purchase and buys Rs 10,000 crore face value of G-Secs across participants. One bank sells it Rs 500 crore face value of a 10-year security at Rs 101.25:

Proceeds to the bank = 500 crore × 101.25 ÷ 100 = Rs 506.25 crore
(accrued interest ignored for simplicity)

That bank now holds Rs 506.25 crore of rupee funds instead of a bond. Repeat across every seller, and roughly Rs 10,000 crore-plus of rupee liquidity has been released into the system — not for a night, but until something reverses it.

Excess liquidity — RBI sells. Months later, surplus funds are chasing overnight lending. RBI sells G-Secs through an OMO. Banks and PDs buy them and pay RBI in rupees. Liquidity is absorbed.

Contrast a buyback. In the same year the Government of India buys back some high-coupon securities before maturity. Here the issuer itself is redeeming its debt — to reduce cost, reduce the number of outstanding securities or improve liquidity — which the workbook lists separately from OMOs, even though both involve G-Secs leaving market hands.

Chapter 1 (Introduction to Interest Rate, Interest Rate Instruments and Fixed Income Markets) defines OMOs in section 1.14.1 on the primary and secondary market of Government Securities, next to buybacks and Government Securities Lending. The same chapter lists OMOs among the central bank's tools for long-term rates and for transmitting monetary policy through the money market. Chapter 8 (Regulatory Environment) adds, in its note on Primary Dealers, that PDs are meant to be an effective conduit for OMOs. Expect a direction question: in excess liquidity, does RBI buy or sell?

• Excess liquidity → RBI sells G-Secs → liquidity absorbed. Tight liquidity → RBI buys → liquidity released. Reversing this is the classic error.
• OMOs adjust liquidity on a durable basis. Day-to-day short-term rate control is through repo and reverse repo.
• OMOs are RBI's operations; buybacks are the Government's. Both involve G-Secs; the actor and purpose differ.
• OMOs are listed among tools for long-term rates, alongside bank rate, CRR and SLR.
• Primary Dealers are a conduit for OMOs, one of the objectives of the PD system introduced in 1995.