OPEN MARKET OPERATIONS (OMO)
1. Context
In its October meeting, the monetary policy committee voted unanimously to keep interest rates unchanged. This was widely expected. But what was not was the RBI Governor stating that the central bank would consider open market operations to manage liquidity.
2. Open market operations by RBI
- Open market operations (OMOs) are a monetary policy tool used by central banks to influence the money supply and interest rates.
- It involves buying and selling government securities in the open market. When the central bank buys government securities, it injects money into the economy. When it sells government securities, it withdraws money from the economy.
- Open market operations (OMOs) are the buying and selling of government securities in the open market by the Reserve Bank of India (RBI) to influence the money supply and interest rates.
- When the RBI buys government securities, it injects money into the economy. This is because the RBI pays for the securities using cash.
- This increase in the money supply can lead to lower interest rates and higher economic growth.
- When the RBI sells government securities, it withdraws money from the economy. This is because the RBI receives cash in exchange for the securities.
- This decrease in the money supply can lead to higher interest rates and lower economic growth.
2.1. Examples of OMOs by RBI
The RBI uses OMOs to achieve its monetary policy objectives, which are to maintain price stability and promote sustainable economic growth. For example, the RBI may conduct OMOs to:
- inject liquidity into the economy to support economic growth during a recession.
- Withdraw liquidity from the economy to control inflation.
- Manage the exchange rate of the rupee.
The RBI has used OMOs to inject liquidity into the economy to support economic growth. For example, in March 2020, the RBI conducted a series of OMOs to inject ₹30,000 crores into the economy in response to the COVID-19 pandemic.
The RBI has also used OMOs to withdraw liquidity from the economy to control inflation. For example, in October 2022, the RBI announced that it would conduct OMO sales of government bonds to withdraw ₹50,000 crores from the economy.
2.2. Advantages and Disadvantages of OMOs by RBI
- OMOs are a flexible tool that the RBI can use to quickly and precisely adjust the money supply and interest rates.
- They are also a relatively transparent tool, as the RBI typically announces its OMO plans in advance.
- OMOs can be complex and difficult to understand. They can also be less effective in influencing the economy during times of financial market stress.
- OMOs are a powerful tool that the RBI can use to manage the money supply and interest rates. They are an important part of the RBI's monetary policy toolkit.
3. Monetary Policy Committee
The Monetary Policy Committee (MPC) is a committee or group responsible for setting the monetary policy of a country, including key interest rates. It is an important institution in many central banks worldwide, including the Reserve Bank of India (RBI).
Key features and functions of a Monetary Policy Committee:
- The MPC typically consists of a group of experts, including both members from the central bank and external members. In the case of the RBI, the MPC is composed of six members: three from the RBI, including the RBI Governor, and three external members appointed by the Government of India.
- The primary function of the MPC is to make decisions regarding the central bank's monetary policy, including setting key policy interest rates. This group assesses various economic indicators, financial market conditions, and other factors to make informed decisions.
- Many MPCs, including the RBI's MPC, operate under a framework of inflation targeting. This means that their primary objective is to achieve and maintain a specific inflation rate within a target range. The committee uses interest rate adjustments to control inflation.
- MPCs aim to operate transparently and communicate their decisions to the public. They often release statements explaining the rationale behind their decisions and their economic outlook.
- The independence of the MPC from political interference is crucial. It allows the committee to make decisions solely based on economic and financial considerations, free from political pressures.
- MPCs typically meet at regular intervals, such as every quarter or month, to review the economy, assess the impact of previous policy decisions, and make adjustments if necessary.
- MPCs engage in economic forecasting to anticipate future economic conditions, including inflation trends. These forecasts guide their monetary policy decisions.
- One of the primary tools at the disposal of an MPC is setting key policy interest rates. For example, the RBI's MPC sets the repo rate (the rate at which banks can borrow money from the central bank) and the reverse repo rate (the rate at which banks can lend money to the central bank).
- Decisions made by the MPC can have a significant impact on financial markets. Changes in policy rates can affect interest rates, exchange rates, and asset prices.
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For Prelims: RBI, Monetary Policy Committee, COVID-19 pandemic, Open market operations, interest rates, inflation,
For Mains:
1. Explain the concept of Open Market Operations (OMO) as a monetary policy tool. How do OMOs impact the money supply and interest rates in an economy? Provide examples of OMOs conducted by the Reserve Bank of India (RBI) to achieve its monetary policy objectives. (250 Words)
2. Explore the concept of inflation targeting and how it influences the primary objective of the Monetary Policy Committee. Discuss the significance of interest rate adjustments in controlling inflation. (250 Words)
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Previous Year Questions
1. Consider the following statements: (UPSC 2021)
1. The Governor of the Reserve Bank of India (RBI) is appointed by the Central Government.
2. Certain provisions in the Constitution of India give the Central Government the right to issue directions to the RBI in the public interest.
3. The Governor of the RBI draws his natural power from the RBI Act.
Which of the above statements is/are correct?
A. 1 and 2 only B. 2 and 3 only C. 1 and 3 only D. 1, 2 and 3
Answer: C
2. Concerning the Indian economy, consider the following: (UPSC 2015)
Which of the above is/are component(s) of Monetary Policy? (a) 1 only (b) 2, 3 and 4 (c) 1 and 2 (d) 1, 3 and 4 Answer: C 3. An increase in Bank Rate generally indicates: (UPSC 2013) (a) Market rate of interest is likely to fall. (b) Central bank is no longer making loans to commercial banks. (c) Central bank is following an easy money policy. (d) Central bank is following a tight money policy. Answer: D 4. Which of the following statements is/are correct regarding the Monetary Policy Committee (MPC)? (UPSC 2017) 1. It decides the RBI's benchmark interest rates. 2. It is a 12-member body including the Governor of RBI and is reconstituted every year. 3. It functions under the chairmanship of the Union Finance Minister. Select the correct answer using the code given below: A. 1 only B. 1 and 2 only C. 3 only D. 2 and 3 only Answer: A 5. With reference to the Indian economy, consider the following statements: (UPSC 2022)
1. An increase in the Nominal Effective Exchange Rate (NEER) indicates the appreciation of the rupee.
2. An increase in the Real Effective Exchange Rate (REER) indicates an improvement in trade competitiveness.
3. An increasing trend in domestic inflation relative to inflation in other countries is likely to cause an increasing divergence between NEER and REER.
Which of the above statements are correct?
A. 1 and 2 only
B. 2 and 3 only
C. 1 and 3 only
D. 1, 2 and 3
Answer: C
6. In the context of vaccines manufactured to prevent COVID-19 pandemic, consider the following statements: (UPSC 2022)
1. The Serum Institute of India produced COVID-19 vaccine named Covishield using mRNA platform.
2. Sputnik V vaccine is manufactured using vector based platform.
3. COVAXIN is an inactivated pathogen based vaccine.
Which of the statements given above are correct?
A. 1 and 2 only B. 2 and 3 only C. 1 and 3 only D. 1, 2 and 3
Answer: B
7. In the context of Indian economy, 'Open Market Operations' refers to (UPSC 2013)
A. borrowing by scheduled banks from the RBI
B. lending by commercial banks to industry and trade
C. purchase and sale of government securities by the RBI
D. None of the above
Answer: C
8. If the interest rate is decreased in an economy, it will (UPSC 2014)
A. decrease the consumption expenditure in the economy
B. increase the tax collection of the Government
C. increase the investment expenditure in the economy
D. increase the total savings in the economy
Answer: C
9. With reference to the Indian economy, consider the following statements: (UPSC 2022)
1. If the inflation is too high, Reserve Bank of India (RBI) is likely to buy government securities.
2. If the rupee is rapidly depreciating, RBI is likely to sell dollars in the market.
3. If interest rates in the USA or European Union were to fall, that is likely to induce RBI to buy dollars.
Which of the statements given above are correct?
A. 1 and 2 only B. 2 and 3 only C. 1 and 3 only D. 1, 2 and 3
Answer: B
10. Read the following passage and answer the question that follows. Your answers to these items should be based on the passage only.
Policymakers and media have placed the blame for skyrocketing food prices on a variety of factors, including high fuel prices, bad weather in key food producing countries, and the diversion of land to non-food production. Increased emphasis, however, has been placed on a surge in demand for food from the most populous emerging economics. It seems highly probable that mass consumption in these countries could be well poised to create a food crisis.
With reference to the above passage, the following assumptions have been made: (UPSC 2021)
1. Oil producing countries are one of the reasons for high food prices.
2. If there is a food crisis in the world in the near future, it will be in the emerging economies. Which of the above assumptions is/are valid?
A. 1 only B. 2 only C. Both 1 and 2 D. Neither 1 nor 2
Answer: D
11. India has experienced persistent and high food inflation in the recent past. What could be the reasons? (UPSC 2011)
1. Due to a gradual switchover to the cultivation of commercial crops, the area under the cultivation of food grains has steadily decreased in the last five years by about 30.
2. As a consequence of increasing incomes, the consumption patterns of the people have undergone a significant change.
3. The food supply chain has structural constraints.
Which of the statements given above are correct?
A. 1 and 2 only B. 2 and 3 only C. 1 and 3 only D. 1, 2 and 3
Answer: B
12. With reference to inflation in India, which of the following statements is correct? (UPSC 2015)
A. Controlling the inflation in India is the responsibility of the Government of India only
B. The Reserve Bank of India has no role in controlling the inflation
C. Decreased money circulation helps in controlling the inflation
D. Increased money circulation helps in controlling the inflation
Answer: C
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Source: Indianexpress
