RBI Announces Second Round Of Operation Twist

The Reserve Bank of India will conduct a second round of bond buying and selling at the end of this month to ease borrowing conditions in money markets.

On Dec. 30, the central bank will purchase Rs 10,000 crore worth of government bonds maturing in 2029 and sell Rs 10,000 crore worth of short-term government bonds maturing in 2020, it said in a statement. The decision came after a “review of the current liquidity and market situation and an assessment of the evolving financial conditions”.

This is the second round of such simultaneous sale of bond purchases and sales, following the Dec. 23 auction. The move is aimed at pushing short-term bond yields higher while lowering long-term yields, akin to the U.S. Federal Reserve’s 2011 Operation Twist.

High-term premia, the difference between the prevailing 10-year government security yield and the repo rate, is an impediment to monetary transmission, according to Ananth Narayan, associate professor of finance at SP Jain Institute of Management and Research. Longer-term yields will come down and short-term yields won’t go up too much as the RBI has been careful and there’s ample liquidity, he said.

On Dec. 30, the RBI will purchase Rs 10,000 crore worth of 6.45 percent government securities maturing in 2029.

At the same time, it will sell Rs 10,000 crore worth of bonds including:

• 6.65 percent government bond maturing on April 9, 2020
• 7.8 percent bond maturing on May 3, 2020
• 8.27 percent bond maturing on June 9, 2020
• 8.12 percent bond maturing on Dec. 10, 2020

Buying longer-term government bonds increases the price of the bond and brings down the yield—bond prices and yields move inversely. Selling the shorter-dated securities increases their yield.

The term premia, which represents the additional interest that must be paid to borrow longer-term money, has remained elevated in the last few months despite several cuts in the repo rate by the RBI’s Monetary Policy Committee.

Since announcing the first simultaneous bond purchases and sales, the gap reduced to 143 basis points on Dec. 26 from 160 basis points on Dec. 19.

“These simultaneous bond purchases in rapid succession is a powerful signal that the central bank wants to bring down the term premia more than anything,” Narayan said.

First Round

In the Dec. 23 auction, the RBI received Rs 20,826 crore worth of bids from market participants. A total of Rs 10,000 crore worth of government bonds maturing in 2029 were purchased by the RBI with a weighted average yield of 6.58 percent.

Market participants submitted Rs 20,330 crore worth of bids for short-term government paper.

In total, the RBI sold Rs 6,825 crore worth of short-term government bonds with the weighted average yield ranging between 5.22 percent and 5.57 percent across four securities.

It was clear from the day of the RBI’s announcement that there would not be a one-off sale and purchase, but multiple rounds, Arvind Chari, head of fixed income and alternatives at Quantum Advisors Pvt. Ltd., said.

“There was an impact on the long-term yields after the first round while short-term yields inched up as was anticipated,” he said. “Operation Twist essentially nullifies any rise in the yield of government bonds due to a slippage in the government’s fiscal deficit.”

Narayan said the Operation Twist strategy is also in sync with the RBI governor’s assertion that monetary and fiscal policy must complement each other.

“Even as it appears inevitable that the government will expand its fiscal deficit, this Operation Twist is bringing down long-term yields and making it easier for the government to fund this expanded deficit,” he said. “Given the surplus banking liquidity in the system, this is effectively deficit monetisation by the RBI.”

The 10-year G-sec yield closed at 6.58 percent on Dec. 26 compared with 6.75 percent on Dec. 19, while the one-year G-sec closed at 5.55 percent versus 5.8 on Dec. 19.