• Investment World
• eWorld
• Catalyst
• Mentor
• Life
• Canvas
• Praxis
• Urban Pulse
• Brand Quest

B. Venkatesh

THE Reserve Bank of India (RBI) will conduct open market operations (OMO) on October 23 and 27. What is OMO? It refers to the buying and selling of government bonds by the RBI. The central bank uses OMO as a monetary tool to regulate money supply in the economy.

The RBI will sell government bonds when it thinks that the money supply in the system is high. Now, commercial banks are the primary investors in government bonds. When commercial banks buy bonds from the RBI, money moves out of the banking system to the central bank. This reduces money supply because money with the RBI does not form part of the money available in the economy.

But what if the RBI is feels that the money supply is low? Then, the central bank will buy bonds from commercial banks and credit the sale proceeds to their accounts.

Importantly, the RBI does not need money to buy bonds as we do. It can simply "create" money to buy bonds. The money created by the RBI adds to the existing money supply in the economy. Buying bonds from commercial banks is one of the several liquidity support facility that the RBI provides to the banking system.

Note that the RBI uses government bonds to facilitate its OMO process. It does not trade in government bonds in the secondary market as banks do. This means that the RBI can only reduce money supply in the system to the extent it holds government bonds.

OMOs typically impact bond prices in the secondary market. When the RBI sells bonds through OMO, banks have lesser money to buy bonds in the secondary market. So, bond prices typically fall. By the same logic, when the RBI buys bonds and increases money supply, bond prices usually go up.

Article E-Mail :: Comment :: Syndication

Stories in this Section
Large-caps: From a bang to a whimper

Copyright © 2003, The Hindu Business Line. Republication or redissemination of the contents of this screen are expressly prohibited without the written consent of The Hindu Business Line