How the Operation Twist moderates bond yields in Indian markets
In the aftermath of the monetary policy, there was a sharp spike in 10-year bond yields in India. The yields shot up from 1.45% to 1.75% in a short span of time after the RBI decided to maintain status quo on repo rates. The financial markets were heavily betting on a 25 bps rate cut and that had been factored into the bond yields. In addition, the RBI made inflation control its core objective and that almost ruled out further rate cuts. That was the reason yields on the ten year benchmark spurted after the status quo on rates was announced in the monetary policy. This was the basis for the RBI’s Operation Twist.
What is Operation Twist
Operation Twist is an attempt by the RBI to regulate yields at the long end of curve. This is done by the RBI buying bonds at the long end and selling bonds at the short end of the curve. This results in more demand for bonds at the long end. This increases the price of these bonds and therefore reduces the yields. At the same time, the sale of bonds at the short end will bring down the prices and raise the yields. In the last few months, the yields at the shorter end of the curve had been falling due to a glut of liquidity. At the same time, the longer end yields had shot up due to higher inflation and also higher inflation expectations. Operation Twist will narrow the yield spread between the short end and the long end making bond markets more predictable.
How Operation Twist works?
How exactly will Operation Twist work in the bond markets? Operation Twist is being launched in the bond markets on 23rd December. Here is how it will be actioned in practice. It will be structured as a special Open Market Operation (OMO), wherein the RBI will buy and sell bonds to the tune of Rs.10,000 crore in the first tranche. The proceeds from sale of short-term securities will be used to buy long-term government securities or bonds to bring down interest rates on long-term securities. RBI will buy 6.45% 2029 G-Secs worth Rs.10,000 crore and fund that by selling shorter maturity government bonds maturing in 2020 across a wide yield spectrum. Of course, the RBI will have the final discretion of accepting or even rejecting the bids.
What does this imply?
Apart from the fact that it normalizes the gap between long yields and short yields, it has immediate implications too. For example, the sharp fall in the bond yields will result in a spike in the bond prices and that would be beneficial to banks and other holders of government securities as we approach the end of the year. Additionally, Operation Twist can also be a useful signaling tool for the government. It gives a clear hint that the government stands to protect the yields in a range to maintain bond price stability. That is a big positive!
