Open Market Operation (OMO) Purchase

Source: BS

Subject: Economy

Context: The RBI announced a ₹1 trillion OMO purchase along with a $5 billion dollar–rupee swap to inject durable liquidity into the banking system as the rupee weakened past 90/$ amid foreign outflows.

About Open Market Operation (OMO) Purchase:

What is an OMO Purchase?

• An Open Market Operation (OMO) purchase is when the RBI buys government securities from banks and financial institutions to inject durable liquidity into the financial system.

• It increases bank reserves, lowers short-term interest rates, and supports smooth monetary transmission.

Purpose of OMO Purchases:

• Inject durable and long-term liquidity into the banking system.

• Smoothen monetary transmission so lending rates fall in line with policy cuts.

• Stabilise money-market rates such as the Weighted Average Call Rate (WACR).

Types of Open Market Operations:

• Expansionary OMO (Liquidity Injection): RBI buys government securities. Increases in bank reserves lead to lower interest rates, which will stimulate lending/investment.

• RBI buys government securities.

• Increases in bank reserves lead to lower interest rates, which will stimulate lending/investment.

• Contractionary OMO (Liquidity Absorption):

• RBI sells government securities. The reduction in money supply leads to a rise in interest rates, which in turn cools inflation.

• RBI sells government securities.

• The reduction in money supply leads to a rise in interest rates, which in turn cools inflation.

• Special OMOs / Operation Twist:

• RBI buys long-term bonds and sells short-term ones simultaneously. Used to shape the yield curve without changing overall liquidity.

• RBI buys long-term bonds and sells short-term ones simultaneously.

• Used to shape the yield curve without changing overall liquidity.

How OMO Purchases Work?

• Assessing Liquidity Conditions: RBI monitors currency pressure, capital flows, call money rates, and banking liquidity.

• Announcing OMO Auctions: RBI notifies the quantity (e.g., ₹1 trillion) and maturity of securities it will purchase.

• Buying Government Securities: Banks sell bonds to the RBI in the auction.

• Settlement: RBI pays banks → their reserves increase → system liquidity expands.

• Market Impact: More liquidity lowers overnight rates. Bond yields soften. Rupee money-markets stabilise even during dollar demand shocks. Transmission improves across banks

• More liquidity lowers overnight rates.

• Bond yields soften.

• Rupee money-markets stabilise even during dollar demand shocks.

• Transmission improves across banks

Significance of OMO Purchases:

• Strengthens Rupee Liquidity During Currency Stress: Foreign outflows reduce rupee liquidity; OMO purchases replenish it.

• Supports Monetary Transmission: Ensures lending rates move in line with repo rate decisions.

• Stabilises Bond Markets: Prevents disorderly spikes in yields that raise government borrowing costs.

• Enhances Banking System Liquidity: Banks get durable funds, enabling more lending to businesses and households.