RBI's Consideration of Open Market Operation (OMO) Sale Shakes Bond Market

• 09 Oct 2023

On 7^th October, 2023, the Reserve Bank of India (RBI) took the bond market by surprise with its recent announcement on considering an Open Market Operation (OMO) sale of government securities to manage liquidity.

Key Points

• Market Surprise: Although no specific schedule was provided, the market now anticipates that OMOs can be announced at any time.
• This uncertainty is due to the understanding that liquidity conditions might tighten over the October-December quarter, making it crucial to address the risk of additional supply near-term.
• Background and Inflation: The retail inflation rate stood at 6.83% in August, and the market was not expecting such a measure from the RBI to withdraw excess liquidity, signaling a somewhat hawkish approach to monetary policy.
• The forthcoming festival season is expected to lead to cash withdrawals from the banking system, further contributing to liquidity tightening.
• Open Market Operation (OMO): OMOs are used by the RBI to adjust rupee liquidity conditions on a durable basis. When there is excess liquidity, the RBI sells government securities to absorb rupee liquidity.
• Conversely, when liquidity is tight, the central bank purchases securities, injecting liquidity into the market.
• OMOs are employed to manage inflation and money supply. However, when liquidity is absorbed, it can lead to higher bond yields.
• RBI's Liquidity Management: The RBI has indicated intent for "active liquidity management" in the future.
• This reflects the central bank's focus on both inflation risks and financial stability.
• The RBI aims to anchor inflation at 4%, emphasizing a proactive approach to achieve this target.