Open Market Operation (OMO) amidst Liquidity Shortage

Context:

More than ₹1.87 lakh crore was offered for purchase under Open Market Operation (OMO) auction by Reserve Bank of India , exceeding its notified ₹40,000 crore by an overwhelming figure.

Highlights of the OMO Auction

• The cutoff prices on bonds were set below secondary market prices because of excessive demand.
• According to market sources, PSU banks were the chief players.
• It already bought government securities worth ₹1 trillion via OMO auctions.

Why does the RBI carry out OMOs?

• The RBI is stepping in with durable liquidity through bond purchase in view of continued liquidity deficit in the banking system for as long as nine consecutive weeks.
• The net liquidity deficit as was ₹1.77 trillion, as reported by RBI sources.
• The central bank injected ₹1.33 trillion through an overnight Variable Rate Repo (VRR) auction conducted on Thursday.
• A14 day VRR auction of ₹75,000 crore is on the calendar.

Impact on Bond Markets

• Corporate bond yields are rising despite RBI’s Monetary Policy Committee (MPC) cutting rates by 25 bps.
• Government bond yields are stable because of active bond purchasing by the RBI via OMOs.
• The gap widened between corporate and government bond yields by 25 bps.
• Short term yields have moved farther up the scale than long term yields, hence creating an inverted yield curve.

What next? More Liquidity Measures Expected

In a scenario where tight liquidity conditions besiege the banking system, market experts suspect more OMOs would be held at intervals in the near future.

• RBI measures to inject durable liquidity include:
  • Further OMOs
  • Cut in Cash Reserve Ratio (CRR)
  • Reducing incremental CRR
  • Foreign Exchange buy sell swaps
  • Long term repo operations

As the RBI goes on with its liquidity support measures, the focus will be around the way these interventions affect bond yields, banking liquidity, and credit conditions. Market participants remain attuned to future OMO announcements as they assess the direction in which the central bank will steer its way through the ongoing liquidity crisis.