RBI : OPEN MARKET OPERATIONS

PROJECT SUBMISSION: INVESTMENT LAW

SUBMITTED BY

Name Of The Candidate:

Aayush
Division: A | Group: A | PRN: 15010224001 | Class Of
2015-20

Of Symbiosis Law School, Noida

Symbiosis International (Deemed University), Pune
In
AUGUST, 2019
Under the guidance of

Mr. Arjun Chaudhari

Course In-charge, Investment Law

SLS, NOIDA

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 CERTIFICATE

The project titled “Regulation of Tariff under Electricity

Act, 2003 in light of National Electricity Plan, 2018”
submitted to the Symbiosis Law School, NOIDA for Energy
Law as part of Internal Assessment is based on my
original work carried out under the guidance of Mr. Arjun
Chaudhari, Course-In-Charge, SLS - NOIDA from July’ 19
to August’ 19. The Research work has not been submitted
elsewhere for award of any degree.

The material borrowed from other sources and

incorporated in the thesis has been duly acknowledged.

I understand that I myself could be held responsible and

accountable for plagiarism, if any, detected later on.

Signature of the Candidate:

Date:

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 ACKNOWLEDGEMENTS

I take this opportunity to express my profound gratitude

and deep regard to my guide Mr. Arjun J. Chaudhari for
his exemplary guidance, monitoring and constant
encouragement throughout the course of this research
project. The blessing, help and guidance given by her
from time to time shall and will always carry me a long
way in the journey of my life on which I have just
embarked. I also take this opportunity to express a deep
sense of gratitude to Symbiosis Law School, Noida and
Symbiosis International Deemed University, Pune for their
cordial support and resources provided by them, which
helped me in completing this task through various stages.
I am obliged to all other faculty members, for the valuable
information provided by them in their respective fields. I
am grateful for their cooperation during the period of my
assignment. Lastly, I thank the Almighty, my Parents, my
Sister and my fellow Co-Learners for their constant
encouragement without which this Research would not
have been possible.

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 INDEX

NO. TITLE PAGE NO.

1 INTRODUCTION 5

2 HISTORY OF OPEN- 5
MARKET
OPERATIONS

3 STEPS INVOLVED IN 5
OPEN-MARKET
OPERATIONS

4 TYPES OF OPEN 8
MARKET
OPERATIONS

5 FUNCTIONING OF 8
OPEN MARKET
OPERATIONS

6 ADVANTAGES AND 10
TARGETS OF OPEN
MARKET
OPERATIONS

7 CONCLUSION 11

RBI - OPEN MARKET OPERATIONS

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INTRODUCTION

An open market procedure is a monetary policy tool involving the

purchase or sale of public and bank securities. This mechanism
affects banks ' reserve status, government securities yield, and
bank loan costs. The RBI sells government securities to negotiate
the credit flow and purchases government securities to boost credit
flow.1

By regulating the quantity of cash circulating in the banking system,

the Reserve Bank affects the level of interest rates. It absorbs cash
from the banking system if the RBF wishes to affect interest rates
upwards. Conversely, if it wishes to affect downward interest rates,
it releases cash into the scheme. By selling securities, the central
bank withdraws cash from the scheme and injects cash into the
scheme by purchasing those securities back. The central bank's
purchase and sale of these securities is called OMO. 2

OMOs are RBI's business activities by selling / purchasing G-Secs to

/from the market with the aim of adjusting the market's rupee
liquidity circumstances on a sustainable basis. When the RBI feels
that the industry has surplus liquidity, it uses securities sales to
suck out the liquidity of the rupee. Likewise, when the
circumstances of liquidity are tight, RBI may buy securities from the
market, thereby releasing liquidity into the market. 3

HISTORY OF OPEN-MARKET OPERATIONS IN INDIA

The R.B.'I. in India. In its early years, it conducted open market

operations on a very limited scale.' Between 1935 and 1944, the
seasonal changes in R.B.I's investment portfolio did not exceed that

1
http://www.miraeassetmf.co.in/uploads/TermofWeek/Open_Market_Operations.pdf.
2
https://www.rbf.gov.fj/getattachment/Publications/Newspaper-Articles/What-is-
OMO_090416.pdf.aspx.
3
https://m.rbi.org.in/Scripts/FAQView.aspx?Id=79#5.

5
of a crore of rupees in any given year.4 Another feature was that
open market operations were mainly net purchases to relieve the
pressure on the money market. Another characteristic was that
open market operations were predominantly net purchases to ease
the money market pressure.5 The Reserve Bank then acted as "the
last resort buyer" for government securities. During the war era,
the Bank's open market operations were in the nature of
government securities '' tap sales' to facilitate war funding.

These transactions took the form of large-scale purchases of

government securities in the post-war era in order to monetize a big
portion of the government's financed debt* However, since 1951,
the net buy trend has been replaced by a two-way stream of
purchases and sales operations. Net sales in the process far
surpassed net purchases during the decade 1952-1971. This was
the result of the so-called "selective and discriminating open market
policy" introduced in November 1951, "whereby seasonal financing
was to be given to banks not by making purchases of government
securities completely, but by giving temporary housing against
government securities collateral. 6 No longer, open market
operations be viewed as a primary channel of seasonal credit.
Instead, it has become a flexible weapon of fiscal monetary policy.

The so-called "Switch" activities have been another characteristic of

the Bank's open market operations strategy since November 1961.
The purchasing activities of the Bank do not influence the size but
the maturity structure of the portfolio of the transactors as it does
not involve purchasing a safety directly, but purchasing a safety
against selling another. Usually such operations are free from short-
4
Some Special Aspects of Open Market Operations of the RBI' - R.B.I* Bulletin, December 19345
p.1498.
5
Ibid. p. 1500.
6
Open Market Operations of the Reserve Bank of India – R.B.I Bulletin, June, 1960 p.799.

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dated to long-dated stocks. To the context such adjustments are
practicable, they help the Reserve Bank in extending the average
maturity of the funded debt held by the economy.
Such activities, however, are aimed primarily at enabling banks and 
other institutional investors to adjust their investment portfolios and 
help cater for the market's changing preferences. Thus, the method 
to be used as a government debt management fiscal instrument.7
STEPS INVOLVED IN OPEN-MARKET OPERATIONS

The central bank takes either of the following two main steps based
on the economic conditions which are known as Open market
operations8:

Buying government bonds from banks

The economy is generally in the recessionary gap stage when the

country's central bank purchases government bonds, with
unemployment being a large issue.

When the central bank purchases government bonds, the money

supply in the economy rises. The enhanced supply of cash lowers
interest rates. The lower interest rates trigger an rise in
consumption and investment expenditure, hence the rise in
aggregate demand. Increased aggregate demand results in an rise
in real GDP.

Therefore, purchasing government bonds from banks improves the

economy's actual GDP, so this technique is also called Expansionary
Monetary Policy.

Thus, buying government bonds from Banks increases the real GDP

of the economy hence this method is also called Expansionary
Monetary policy.
7
Alok Ghosh Cartel Techniques in Monetary Management (Calcutta, 1971) p.50.
8
https://www.wallstreetmojo.com/open-market-operations/

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 Selling Government Bonds to Banks

When the economy faces inflation, central banks sell government

bonds to banks. By selling government bonds to banks, the central
bank attempts to regulate inflation.

When central bank sells public bonds, it sucks the economy's

surplus cash. This creates a decline in the supply of cash. A reduced
supply of cash leads interest rates to rise. Higher interest rates
cause a drop in consumption and investment expenditure and thus
a drop in aggregate demand. The drop in aggregate demand leads
to a drop in real GDP.

Thus, selling government bonds to Banks decreases the real GDP of

the economy hence this method is also called Contractionary
Monetary policy.

TYPES OF OPEN-MARKET OPERATIONS

 Outright purchase (PEMO)

Through PEMO, RBI purchases and sells bonds for the long
term expansion or contracting of the money supply.9

 Repurchase Agreement (REPO)

RBI engages in the sale or buy of securities through REPO wit
h a repurchase condition.10

FUNCTIONING OF OPEN-MARKET OPERATIONS

 Monetary objectives are used to guide this execution, such as

inflation, interest rates, or exchange rates.

 Since most money now exists in the form of electronic records

rather than paper, open market operations are simply
9
https://www.goodreturns.in/classroom/2013/07/what-are-open-market-operation-omos-
191708.html.
10
Ibid.

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 performed by electronically increasing or decreasing (crediting
or debiting) the amount of base money a bank has in its
central bank reserve account. Therefore, the method literally
does not involve a fresh currency. However, this will improve
the necessity of the central bank to print currency in return
for a reduction in its electronic equilibrium when the member
bank demands banknotes.

 The central bank must act if it wants to keep the short-term

interest rate when there is an enhanced demand for base
money. It does this by increasing base money supply. The
central bank goes to the open market to buy a financial asset,
such as government bonds. To pay for these assets, bank
reserves in the form of new base money (for example newly
printed cash) are transferred to the seller's bank and the
seller's account is credited. Thus, the total amount of base
money in the economy is increased. Conversely, if the central
bank sells these assets in the open market, the amount of
base money held by the buyer's bank is decreased, effectively
destroying base money.

ADVANTAGES AND TARGETS OF OPEN-MARKET

OPERATIONS11

 INFLATION AND INTEREST RATE TARGETING

Interest rates and inflation are the main objective of this operation.
The central is trying to keep inflation within a certain range so that
the country's economy grows at a stable and steady rate. The
central bank has a close relationship with interest rates to take this
into account. When the central bank provides other banks and the
public securities and government bonds, it also impacts the loan
supply and demand.The buyers of the bonds deposit the money
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https://www.wallstreetmojo.com/open-market-operations/

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from their account to the central bank’s account thereby decreasing
their own reserves. With the commercial banks buying such
securities they will have less money to lend to the general public
thus reducing their credit creation capacity. Thereby, impacting the
supply of credit.

When the central bank sells the securities, the price of the bonds
decreases and as bond prices and interest rates are inverted, the
interest rates rise. As interest rates increase, loan demand is
declining.

With the decrease in supply and demand for credit due to less
reserves and high-interest rates, consumption reduces thus
reducing inflation.

When the central bank buys the securities the cycle is reversed,
inflation rises and interest rates decrease.

 MONEY-SUPPLY TARGETING

The central bank can target and regulate the economy's cash supply
.The central bank attempts to keep appropriate liquidity in the banki
ng system when it feels elevated liquidity is being attempted by selli
ng bonds and vice versa to suck the surplus liquidity. Eg. In order to
maintain sustainable liquidity, Reserve Bank of India conducted two
Open Market Operations (OMO) purchase auctions of Rs 10000
crores on June 21, 2018 and July 19, 2018.

This can be done to check the fiat currencies and other foreign
currencies value of the currency.

• Open Market Operations also offer adaptability to a large

number of institutions, freedom from bargaining power constraints,
suitability to recurrent peacetime application, duration of use,

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impersonal character, reversibility of direction, or precision of
pressure.12

CONCLUSION

Open market activities are the monetary policy instrument of the

central bank to preserve the economy's inflation, interest rates,
cash supply, and liquidity. Depending on the financial
circumstances, the central bank may purchase or sell securities
under such activities. Permanent measures are usually taken to
target short-term inflation and interest rates, while temporary
measures are usually taken.

12
Joseph Aschheim - Techniques of Monetary Control (Baltimore, 1965) p, 107.

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 BIBLIOGRAPHY

 http://www.miraeassetmf.co.in/uploads/TermofWeek/Open_Mar
ket_Operations.pdf.
 https://www.rbf.gov.fj/getattachment/Publications/Newspaper-
Articles/What-is-OMO_090416.pdf.aspx.
 https://m.rbi.org.in/Scripts/FAQView.aspx?Id=79#5.
 Some Special Aspects of Open Market Operations of the RBI' -
R.B.I* Bulletin, December 19345 p.1498.
 Open Market Operations of the Reserve Bank of India – R.B.I
Bulletin, June, 1960 p.799.
 Alok Ghosh Cartel Techniques in Monetary Management
(Calcutta, 1971) p.50.
 https://www.wallstreetmojo.com/open-market-operations/
 https://www.goodreturns.in/classroom/2013/07/what-are-
open-market-operation-omos-191708.html.
 https://www.wallstreetmojo.com/open-market-operations/
 Joseph Aschheim - Techniques of Monetary Control
(Baltimore, 1965) p, 107.

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