Operation Twist

WHY IN NEWS?

The Reserve Bank of India (RBI) announced `Operation Twist' to help reduce yields on longer tenor sovereign debt, which now carries higher costs despite cuts in interest rates.

ABOUT OPERATION TWIST

• ‘Operation Twist’ is RBI’s simultaneous selling of short-term securities and buying of long term securities through open market operations (OMO).
• Under this mechanism, the short-term securities are transitioned into long-term securities.
• As the central bank buys long-term securities (bonds), their demand rise which in turn pushes up their prices.
• However, the bond yield comes down with an increase in prices. Yield is the return an investor gets on his (bond) holding/investment.
• The interest rate in an economy is determined by yield. Thus, lower long-term interest rates mean people can avail long-term loans (such as buying houses, cars or financing projects) at lower rates.
• This also results in a dip in the expected returns from long-term savings which tilts the balance from saving towards spending. Hence, cheaper retail loans can help encourage consumption spending which is the largest GDP component in the economy.
• Fixed income investors with higher exposure to long term debt will benefit from easing yield of long-term bonds.
• Consumers/borrowers will also profit from ‘Operation Twist’ as the retail loans will now get cheaper.
• Previously banks were forced to price their retail loans at higher rates owing to high yields on long-term government borrowings. Cheaper retail loans mean a boost in consumption and spending in the economy which in turn will revive growth