Prelims Level
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Prelims Syllabus : Economy- Banking Mains Syllabus : Indian Economy and issues relating to plann ing, mobilization, of resources, growth, development and employment.

In news:

The Reserve Bank had decided to scale up the amount of liquidity infusion by ₹ 10,000 crore to ₹50,000 crore this month, after a review of the evolving liquidity conditions

  • Liquidity in the banking system has been under pressure, particularly since October, and the deficit is estimated at around Rs 1 lakh crore.
  • The central bank had earlier announced to infuse liquidity amounting to ₹40,000 crore through the purchase of government securities under Open Market Operations (OMOs) during December.
  • While the RBI had earlier announced plans to inject Rs 40,000 crore through OMOs this month, the shortfall has continued due to advance ta
    x outflows. The central bank said on a review of the evolving liquidity conditions;
  • However, the central bank has infused durable liquidity of Rs 36,000 crore in October and Rs 50,000 crore in the following month through OMOs or the purchase of government securities. The RBI disclosed in the fifth bi-monthly monetary policy earlier this month that so far during this fiscal, it has injected total durable liquidity of Rs 1.36 trillion
  • It has been decided to scale up the amounts to be purchased in the remaining two OMO auctions (it has already conducted two) to Rs 15,000 crore each from Rs 10,000 crore. Consequently, the total injection of durable liquidity for December will be Rs 50,000 crore.
  • “The RBI went on to add that based on an assessment of the durable liquidity needs, it has decided to conduct purchase of government securities under OMOs for Rs 50,000 crore in January 2019. This operation will be conducted through five auctions of Rs 10,000 crore each.
  • The RBI has already injected Rs 20,000 crore through two OMO purchase auctions.
  • It further said the exact calibration of the quantum of OMO would depend on sustained changes in the behavior of currency in circulation, the magnitude of sterilization operations for RBI’s forex operationsand other relevant factors

Open market operations (OMO):

What is it?

  • Open market operations are conducted by the RBI by way of sale or purchase of government securities (g-secs) to adjust money supply conditions. The central bank sells g-secs to suck out liquidity from the system and buys back g-secs to infuse liquidity into the system.
  • These operations are often conducted on a day-to-day basis in a manner that balances inflation while helping banks continue to lend.
  • The RBI uses OMO along with other monetary policy tools such as repo rate, cash reserve ratio and statutory liquidity ratio to adjust the quantum and price of money in the system.

What its Significance?

  • In India, liquidity conditions usually tighten during the second half of the financial year (mid-October onwards).
  • This happens because the pace of government expenditure usually slows down, even as the onset of the festival season leads to a seasonal spike in currency demand. Moreover, activities of foreign institutional investors, advance tax payments, etc. also cause an ebb and flow of liquidity.
  • However, the RBI smoothens the availability of money through the year to make sure that liquidity conditions don’t impact the ideal level of
    interest rates it would like to maintain in the economy.
  • Liquidity management is also essential so that banks and their borrowers don’t face a cash crunch. The RBI buys g-secs if it thinks systemic liquidity needs a boost and offloads them if it wants to mop up excess money. The central bank’s signal that it will move to a
    ‘neutral’ liquidity stance from a ‘deficit’ stance, hints at more liquidity in the system in future. This could arm banks with more funds for lending, and lead to softer interest rates in the economy. This is good news for both businesses as well as individuals.
  • However, large open market purchases by the RBI can give the government a helping
    hand in its borrowing programme and are frowned upon for this reason. In April 2006, the RBI was barred from subscribing to primary bond issues of the government.
  • This was done to put an end to the monetisation of debt by the Reserve Bank. However, that didn’t stop the process.
  • With rising fiscal deficit, the RBI has been criticized for accommodating larger government debt by way of OMO.
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