RBI : OPEN MARKET OPERATIONS

PROJECT SUBMISSION: INVESTMENT LAW

SUBMITTED BY

Name of The Candidate:

Aayush
Division: A | Group: A | PRN: 15010224001 | Class Of
2015-20

Of Symbiosis Law School, Noida

Symbiosis International (Deemed University), Pune
In
AUGUST, 2019
Under the guidance of

Mr. Arjun Chaudhari

Course In-charge, Investment Law

SLS, NOIDA

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 CERTIFICATE

The project titled “Regulation of Tariff under Electricity Act,

2003 in light of National Electricity Plan, 2018” submitted
to the Symbiosis Law School, NOIDA for Energy Law as part
of Internal Assessment is based on my original work carried
out under the guidance of Mr. Arjun Chaudhari, Course-In-
Charge, SLS - NOIDA from July’ 19 to August’ 19. The
Research work has not been submitted elsewhere for award
of any degree.

The material borrowed from other sources and incorporated

in the thesis has been duly acknowledged.

I understand that I myself could be held responsible and

accountable for plagiarism, if any, detected later on.

Signature of the Candidate:

Date:

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 ACKNOWLEDGEMENTS

I take this opportunity to express my profound gratitude

and deep regard to my guide Mr. Arjun J. Chaudhari for his
exemplary guidance, monitoring and constant
encouragement throughout the course of this research
project. The blessing, help and guidance given by him from
time to time shall and will always carry me a long way in
the journey of my life on which I have just embarked. I also
take this opportunity to express a deep sense of gratitude
to Symbiosis Law School, Noida and Symbiosis
International Deemed University, Pune for their cordial
support and resources provided by them, which helped me
in completing this task through various stages. I am obliged
to all other faculty members, for the valuable information
provided by them in their respective fields. I am grateful
for their cooperation during the period of my assignment.
Lastly, I thank the Almighty, my Parents, my Sister and my
fellow Co-Learners for their constant encouragement
without which this Research would not have been possible.

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 INDEX

NO. TITLE PAGE NO.

1 INTRODUCTION 5

2 HISTORY OF OPEN- 5
MARKET
OPERATIONS

3 STEPS INVOLVED IN 5
OPEN-MARKET
OPERATIONS

4 TYPES OF OPEN 8
MARKET
OPERATIONS

5 FUNCTIONING OF 8
OPEN MARKET
OPERATIONS

6 OBJECTIVES OF 10
OPEN MARKET
OPERATIONS

7 LIMITATIONS OF 12
OPEN MARKET
OPERATIONS

8 CONCLUSION 12

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 WHAT IS RBI - OPEN MARKET OPERATIONS
[OMO]?

INTRODUCTION

An open market procedure is a monetary policy tool involving the

purchase or sale of public and bank securities. This mechanism
affects banks ' reserve status, government securities yield, and bank
loan costs. The RBI sells government securities to negotiate the credit
flow and purchases government securities to boost credit flow. 1

By regulating the quantity of cash circulating in the banking system,

the Reserve Bank affects the level of interest rates. It absorbs cash
from the banking system if the RBF wishes to affect interest rates
upwards. Conversely, if it wishes to affect downward interest rates,
it releases cash into the scheme. By selling securities, the central
bank withdraws cash from the scheme and injects cash into the
scheme by purchasing those securities back. The central bank's
purchase and sale of these securities is called OMO. 2

OMOs are RBI's business activities by selling / purchasing G-Secs to

/from the market with the aim of adjusting the market's rupee
liquidity circumstances on a sustainable basis. When the RBI feels
that the industry has surplus liquidity, it uses securities sales to suck
out the liquidity of the rupee. Likewise, when the circumstances of
liquidity are tight, RBI may buy securities from the market, thereby
releasing liquidity into the market.3

HISTORY OF OPEN-MARKET OPERATIONS IN INDIA

1
http://www.miraeassetmf.co.in/uploads/TermofWeek/Open_Market_Operations.
pdf.
2
https://www.rbf.gov.fj/getattachment/Publications/Newspaper-Articles/What-is-
OMO_090416.pdf.aspx.
3
https://m.rbi.org.in/Scripts/FAQView.aspx?Id=79#5.

5
The R.B.'I. in India. In its early years, it conducted open market
operations on a very limited scale.' Between 1935 and 1944, the
seasonal changes in R.B.I's investment portfolio did not exceed that
of a crore of rupees in any given year.4 Another feature was that open
market operations were mainly net purchases to relieve the pressure
on the money market. Another characteristic was that open market
operations were predominantly net purchases to ease the money
market pressure.5 The Reserve Bank then acted as "the last resort
buyer" for government securities. During the war era, the Bank's
open market operations were in the nature of government securities
''tap sales' to facilitate war funding.

These transactions took the form of large-scale purchases of

government securities in the post-war era in order to monetize a big
portion of the government's financed debt* However, since 1951, the
net buy trend has been replaced by a two-way stream of purchases
and sales operations. Net sales in the process far surpassed net
purchases during the decade 1952-1971. This was the result of the
so-called "selective and discriminating open market policy"
introduced in November 1951, "whereby seasonal financing was to
be given to banks not by making purchases of government securities
completely, but by giving temporary housing against government
securities collateral.6 No longer, open market operations be viewed
as a primary channel of seasonal credit. Instead, it has become a
flexible weapon of fiscal monetary policy.

4
Some Special Aspects of Open Market Operations of the RBI' - R.B.I* Bulletin,
December 19345 p.1498.
5
Ibid. p. 1500.
6
Open Market Operations of the Reserve Bank of India – R.B.I Bulletin, June,
1960 p.799.

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The so-called "Switch" activities have been another characteristic of
the Bank's open market operations strategy since November 1961.
The purchasing activities of the Bank do not influence the size but
the maturity structure of the portfolio of the transactors as it does
not involve purchasing a safety directly, but purchasing a safety
against selling another. Usually such operations are free from short-
dated to long-dated stocks. To the context such adjustments are
practicable, they help the Reserve Bank in extending the average
maturity of the funded debt held by the economy.

Such activities, however, are aimed primarily at enabling banks and

other institutional investors to adjust their investment portfolios an
d help cater for the market's changing preferences. Thus, the metho
d to be used as a government debt management fiscal instrument. 7

In India, OMO have used to cater to the requirements of Treasury

more than Banks that has been stated categorically by banks:8

“In general, open market operations have been used in India more
to assist the Government in its borrowing operations and to maintain
orderly conditions in the Government securities market than for
influencing the availability and cost of credit”

STEPS INVOLVED IN OPEN-MARKET OPERATIONS

The capacity of a central bank to conduct open market operations

depends upon the type and quantity of resources it can house in its
portfolio as well as the depth and size of git-edged market. The
central bank takes either of the following two main steps based on

7
Alok Ghosh Cartel Techniques in Monetary Management (Calcutta, 1971) p.50.
8
Open Market Operations of the B.B.I.' - E.B.I.Bulletin, June 19601 p.799.

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the economic conditions which are known as Open market
operations9:

Buying government bonds from banks

The economy is generally in the recessionary gap stage when the
country's central bank purchases government bonds, with
unemployment being a large issue.

When the central bank purchases government bonds, the money

supply in the economy rises. The enhanced supply of cash lowers
interest rates. The lower interest rates trigger an rise in consumption
and investment expenditure, hence the rise in aggregate demand.
Increased aggregate demand results in an rise in real GDP.

Therefore, purchasing government bonds from banks improves the

economy's actual GDP, so this technique is also called Expansionary
Monetary Policy.

Thus, buying government bonds from Banks increases the real GDP
of the economy hence this method is also called Expansionary
Monetary policy.

Selling Government Bonds to Banks

When the economy faces inflation, central banks sell government
bonds to banks. By selling government bonds to banks, the central
bank attempts to regulate inflation.

When central bank sells public bonds, it sucks the economy's surplus
cash. This creates a decline in the supply of cash. A reduced supply
of cash leads interest rates to rise. Higher interest rates cause a drop
in consumption and investment expenditure and thus a drop in

9
https://www.wallstreetmojo.com/open-market-operations/

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aggregate demand. The drop in aggregate demand leads to a drop in
real GDP.

Thus, selling government bonds to Banks decreases the real GDP of

the economy hence this method is also called Contractionary
Monetary policy.

TYPES OF OPEN-MARKET OPERATIONS

 Outright purchase (PEMO)
Through PEMO, RBI purchases and sells bonds for the long
term expansion or contracting of the money supply.10

 Repurchase Agreement (REPO)

RBI engages in the sale or buy of securities through REPO wit
h a repurchase condition.11

FUNCTIONING OF OPEN-MARKET OPERATIONS

 Monetary objectives are used to guide this execution, such as

inflation, interest rates, or exchange rates.

 Since most money now exists in the form of electronic records

rather than paper, open market operations are simply
performed by electronically increasing or decreasing (crediting
or debiting) the amount of base money a bank has in its central
bank reserve account. Therefore, the method literally does not
involve a fresh currency. However, this will improve the
necessity of the central bank to print currency in return for a
reduction in its electronic equilibrium when the member bank
demands banknotes.

10
https://www.goodreturns.in/classroom/2013/07/what-are-open-market-
operation-omos-191708.html.
11
Ibid.

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  The central bank must act if it wants to keep the short-term
interest rate when there is an enhanced demand for base
money. It does this by increasing base money supply. The
central bank goes to the open market to buy a financial asset,
such as government bonds. To pay for these assets, bank
reserves in the form of new base money (for example newly
printed cash) are transferred to the seller's bank and the
seller's account is credited. Thus, the total amount of base
money in the economy is increased. Conversely, if the central
bank sells these assets in the open market, the amount of base
money held by the buyer's bank is decreased, effectively
destroying base money.

OBJECTIVES OF OPEN-MARKET OPERATIONS

Open Market Operations are employed as fiscal policy to assist in
government borrowing, debt control and veiling budgetary gaps.12

 INFLATION AND INTEREST RATE TARGETING

Interest rates and inflation are the main objective of this operation 13.
The central is trying to keep inflation within a certain range so that
the country's economy grows at a stable and steady rate.14 The
central bank has a close relationship with interest rates to take this
into account.15 When the central bank provides other banks and the
public securities and government bonds, it also impacts the loan
supply and demand.16 The buyers of the bonds deposit the money
from their account to the central bank’s account thereby decreasing
their own reserves.17 With the commercial banks buying such

12
https://shodhganga.inflibnet.ac.in/bitstream/10603/157474/10/10_chapter%20
7.pdf
13
https://www.wallstreetmojo.com/open-market-operations/
14
Ibid.
15
Ibid.
16
Ibid.
17
Ibid.

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securities they will have less money to lend to the general public thus
reducing their credit creation capacity.18 Thereby, impacting the
supply of credit.19

When the central bank sells the securities, the price of the bonds
decreases and as bond prices and interest rates are inverted, the
interest rates rise.20 As interest rates increase, loan demand is
declining.21

With the decrease in supply and demand for credit due to less
reserves and high-interest rates, consumption reduces thus reducing
inflation.22

When the central bank buys the securities the cycle is reversed,
inflation rises and interest rates decrease.23

 MONEY-SUPPLY TARGETING

The central bank can target and regulate the economy's cash supply
.The central bank attempts to keep appropriate liquidity in the banki
ng system when it feels elevated liquidity is being attempted by selli
ng bonds and vice versa to suck the surplus liquidity. Eg. In order to
maintain sustainable liquidity, Reserve Bank of India conducted two
Open Market Operations (OMO) purchase auctions of Rs 10000 crores
on June 21, 2018 and July 19, 2018.

This can be done to check the fiat currencies and other foreign
currencies value of the currency.

• Open Market Operations also offer adaptability to a large

number of institutions, freedom from bargaining power constraints,

18
Ibid.
19
Ibid.
20
Ibid.
21
Ibid.
22
Ibid.
23
Ibid.

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suitability to recurrent peacetime application, duration of use,
impersonal character, reversibility of direction, or precision of
pressure.24

ADVANTAGES OF OPEN-MARKET OPERATIONS

Firstly, such operations have the effect of bringing central bank close
in touch with the portfolios of multifarious classes of lenders.25 This
means that it can impact the activities of non-bank financial
intermediaries.26

Secondly, it includes a direct draft on the member banks ' reserve

base.27 In this regard, it resembles the method of variable reserve
ratio and differs from the strategy of the bank rate, which generates
its effect indirectly by changing the price of obtaining the funds
through central bank borrowing.28

Thirdly, in an ever-changing environment, open market operations

prove to be worthwhile in a better way than manipulating the bank
rate. A country's central bank, if it so desires, can continually and
unobtrusively, on a daily or week-to-week basis, play with the
technique of open market operations.

LIMITATIONS OF OPEN MARKET OPERATIONS

The applicability of this technique is marred by institutional and
technical difficulties significantly a narrow security market. 29 Further,

24
Joseph Aschheim - Techniques of Monetary Control (Baltimore, 1965) p, 107.
25
Open Market Operations Chapter 7
26
Joseph Aschheim - Techniques of Monetary Control (Baltimore,1965) p, 17
27
Open Market Operations Chapter 7
28
Ibid.
29
Open Market Operations Chapter 7

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OMO are likely to be a not viable mechanism for implementing
monetary policy.30

CONCLUSION
The Open Market Operations of the Reserve Bank of India is tilted
towards the sale of government securities and generally accords with
the bank’s overall restrictive policy.31 However, this restraint has not
been in any way reflected in the price which keeps on soaring and
the banking system has maintained a good deal of liquidity. 32

Open market activities are the monetary policy instrument of the

central bank to preserve the economy's inflation, interest rates, cash
supply, and liquidity. Depending on the financial circumstances, the
central bank may purchase or sell securities under such activities.
Permanent measures are usually taken to target short-term inflation
and interest rates, while temporary measures are usually taken.

30
Graeme S. Dorrance ’The Instruments of Monetary Policy in Countries Without
Highly Developed Capital Markets’ - I.M.F. Staff Papers* Vol. XII, 1965*, p. 273.
31
Open Market Operations Chapter 7
32
Ibid.

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 REFERENCES

 http://www.miraeassetmf.co.in/uploads/TermofWeek/Open_Mar
ket_Operations.pdf.
 https://www.rbf.gov.fj/getattachment/Publications/Newspaper-
Articles/What-is-OMO_090416.pdf.aspx.
 https://m.rbi.org.in/Scripts/FAQView.aspx?Id=79#5.
 Some Special Aspects of Open Market Operations of the RBI' -
R.B.I* Bulletin, December 19345 p.1498.
 Open Market Operations of the Reserve Bank of India – R.B.I
Bulletin, June, 1960 p.799.
 Alok Ghosh Cartel Techniques in Monetary Management (Calcutta,
1971) p.50.
 https://www.wallstreetmojo.com/open-market-operations/
 https://www.goodreturns.in/classroom/2013/07/what-are-open-
market-operation-omos-191708.html.
 https://www.wallstreetmojo.com/open-market-operations/
 Joseph Aschheim - Techniques of Monetary Control (Baltimore,
1965) p, 107.

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