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Chapter 4.
Market Operations Wednesday, 18 December 2024 5:16 PM
Objective and Framework of Market Operations
• The primary objective of the RBI’s market operations is to enable the transmission of monetary policy to the financial system. • Market Operations Framework: • Divided into: 1. Monetary Policy Operations: Managing liquidity and ensuring the operating target (Weighted Average Call Rate - WACR) is aligned with the policy repo rate. 2. Foreign Exchange Operations: Managing the currency market and stabilizing exchange rates when required.
I. Monetary Policy Operations
1. Operating Target: • The Weighted Average Call Rate (WACR) is the RBI’s operating target. • It reflects the cost of overnight funds in the interbank market. 2. Liquidity Management Framework: • RBI uses Liquidity Adjustment Facility (LAF) and Marginal Standing Facility (MSF) to address short-term or transient liquidity needs. • For enduring liquidity issues, tools include: • Long-Term Repo Operations (LTROs). • Open Market Operations (OMO). • Market Stabilization Scheme (MSS). • Cash Reserve Ratio (CRR) adjustments. • Forex Swaps (USD/INR swaps).
Key Instruments of Monetary Policy Operations
1. Liquidity Adjustment Facility (LAF): • Introduced in 2000 as the primary tool for day-to-day liquidity management. • Includes: • Repo: RBI lends to banks at the policy repo rate. • Reverse Repo: RBI absorbs excess liquidity from banks. 2. Marginal Standing Facility (MSF): • Allows banks to borrow overnight funds beyond their LAF limits. • Provides a safety valve for unanticipated liquidity needs, but at a penal rate (above the repo rate). 3. Open Market Operations (OMO): • RBI buys or sells government securities outright to manage liquidity. • Purchase of securities injects liquidity, while sales absorb liquidity. 4. Market Stabilization Scheme (MSS): • Introduced in 2004 to manage excess liquidity from large capital inflows. • Uses government securities issued explicitly for sterilization purposes. • Proceeds are maintained in a separate account with the RBI. 5. Long-Term Repo Operations (LTRO): • Introduced in 2020 to provide long-term liquidity to banks (1-3 years) at the repo rate. • Helps in stabilizing credit markets during economic slowdowns. 6. Cash Reserve Ratio (CRR): • A portion of banks’ NDTL that must be kept with the RBI. • Increasing CRR absorbs liquidity; decreasing CRR injects liquidity. 7. Forex Swap Auctions: • RBI conducts USD/INR swaps to inject or absorb rupee liquidity. • For example, selling USD injects rupee liquidity into the system.
Revised Liquidity Management Framework (2020)
• Based on recommendations of an Internal Working Group (2019). • Key updates include: • Conducting 14-day Variable Rate Repo/Reverse Repo Auctions as the main liquidity tool. • Flexibility to conduct fine-tuning operations for overnight or longer tenors. • Streamlining the number of instruments for efficient liquidity management.
II. Foreign Exchange Operations
1. RBI’s Role in the Foreign Exchange Market: • Intervenes in the forex market to manage volatility in the Indian rupee (INR). • Objectives: • Ensure orderly market conditions. • Manage excess volatility. • Maintain adequate foreign exchange reserves. 2. Key Foreign Exchange Instruments: • Spot Market Interventions: Buying or selling foreign currency directly in the spot market. • Forward Market Operations: Engaging in contracts for future delivery of foreign currency. • Forex Swaps: Used to manage liquidity and stabilize the currency market. 3. Management of Forex Reserves: • RBI maintains reserves to support exchange rate stability and provide a buffer against external shocks. • Reserves are invested in safe and liquid instruments, such as US Treasury bonds.
Special Liquidity Measures During Crises
1. Global Financial Crisis (2008): • RBI implemented OMO purchases and CRR reductions to inject liquidity. • Introduced special refinance facilities for financial institutions. 2. COVID-19 Pandemic (2020): • Launched targeted LTROs (TLTROs) to direct liquidity to stressed sectors. • Conducted Operation Twist: Simultaneous purchase of long-term and sale of short-term government securities to manage yields.
Conclusion
The RBI’s market operations focus on liquidity management and foreign
exchange stability to ensure effective monetary policy transmission. By using diverse instruments, including LAF, OMO, and forex swaps, the RBI maintains the WACR close to the policy repo rate and ensures orderly financial market conditions. During crises, the RBI introduces innovative measures like TLTROs and Operation Twist to address economic disruptions effectively.