Open Market Operation (OMO) Sale of Government Securities

October 9, 2023

The Reserve Bank of India (RBI) recently made an unexpected announcement regarding the consideration of Open Market Operation (OMO) sales of government securities. While the RBI did not specify a timeline for this move, it caught the bond market by surprise, leading to a sudden increase in the yield on benchmark 10-year government bonds.

Surprise Announcement and Market Reaction

The RBI’s announcement regarding the possibility of OMO sales took the bond market by surprise. As a result, the yield on the benchmark 10-year government bonds rose by 12 basis points to reach 7.34 percent. Market participants anticipate an OMO operation in the near future, which could tighten liquidity in the system.

Anticipating Liquidity Tightening

While there is no specific calendar for OMO sales, the market is on edge, as such operations can be announced at any time. The perception is that the most favorable liquidity conditions will occur during the October-December quarter, leading to speculation that the RBI may act sooner rather than later. The potential additional supply of government securities through OMOs in the near term is a significant concern for market participants.

RBI’s Intent and Inflation Concerns

The unexpected mention of OMO sales aligns with the RBI’s emphasis on “active liquidity management.” The central bank appears inclined toward tighter liquidity conditions, driven by concerns about inflation risks and financial stability. The RBI aims to anchor inflation at 4 percent, which necessitates a proactive approach, not just keeping it below the upper band of the target range (at 6 percent).

Festive Season Impact

Historically, the period from October to May witnesses high cash withdrawals due to festive and wedding seasons, reducing durable liquidity in the banking system. This factor seems to be a focus of the RBI’s liquidity management. While the specific OMO calendar remains undisclosed, the central bank’s reference to OMO sales at this stage leaves room for speculation about the level of liquidity and the quantum of OMO sales.

Current Liquidity Position

The RBI has hinted at the possibility of conducting OMO sales to absorb excess liquidity buildup. Over the past month, the RBI has conducted OMO sales in the secondary market, resulting in net sales of Rs 6,200 crore in September. Additionally, the RBI implemented an incremental cash reserve ratio (I-CRR) in August, which withdrew Rs 1.1 lakh crore from the banking system. Despite a gradual withdrawal of the I-CRR, systemic liquidity remained in deficit since mid-September due to quarterly tax outflows and GST payments.

Future Liquidity Dynamics

While increased government spending and the removal of the I-CRR can potentially boost systemic liquidity, the RBI remains cautious about rising currency demand ahead of the festive season. This balancing act highlights the RBI’s commitment to maintaining liquidity within a specified range while addressing inflation concerns and ensuring financial stability.

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