Open Market Operation (OMO) by Regulator
Open Market Operation (OMO) means the purchase or sale of government securities by the central bank of a country from / to the banks on its own account. The purpose of open market operation is ensuring sufficient liquidity in the market to maintain interest rate and credit availability. In India, through OMO, Reserve Bank of India (RBI) regulates the supply of the money in market and ensures credit facilities (loans and advances) to public at the desired interest rate. OMO is one of the quantitative credit control measures adopted by RBI.
Principal motives behind Open Market Operation (OMO)
Central bank is the custodian of monetary policy in almost all countries. Monetary policy aims growth with controlled inflation and availability of credit at reasonable cost of interest. OMOs are carried out to
• Regulate the availability of funds with the commercial banks to influence their power of lending
• Influence the rates of interest of lending by controlling funds in the market.
Different types of open market operations are adopted by the regulator during periods of inflation and deflation. The central banks absorb liquidity during periods of inflation and inject liquidity during periods of deflation.
Open Market Operation (OMO) during periods of inflation
Inflation is the state of economy wherein the prices are exhibiting an increasing trend. Inflation is often associated with easy availability of funds. During periods of inflation, regulator withdraws money from market to minimise supply of funds. This is implemented by selling government securities in the market. RBI sells security to banks and receives cash from them, thereby reducing the cash in the market. As the liquidity gets reduced, the interest of borrowing goes up making borrowing less remunerative. This method of OMO is known as contractionary monetary policy or hard monetary policy (quantitative tightening or QT policy).
Open Market Operation (OMO) during periods of deflation
Deflation is the state of economy that exhibits a decrease in the price levels of goods and services. This occurs when inflation rate goes below zero. This state is normally witnessed during periods of economic slowdown / crisis. During this period, regulators adopt expansionary monetary policy or soft monetary policy (quantitative easing or QE policy) by injecting liquidity into the market. For this, RBI purchases government security from banks in return for cash. The availability of cash with banks increases forcing them to reduce the cost of funds. Loans and advances at cheaper rates encourage borrowing and stimulate investments. This in turn generates more employment opportunities and enhances income of public. This process brings the economy back into the track of recovery and growth.
Open Market Operation (OMO)- Challenges in India
OMO operations in India have the following hurdles:
1. Lack of adequate and well organised securities markets
2. Reserve ratio of commercial banks are not stable
3. Absence of direct linkage between interest rate and demand for credit
4. Pessimistic or optimistic attitude of business community with regard to investment conditions.
OMO is observed to be more effective in developed countries like the USA and the UK because of developed securities markets.
To enhance efficiency of open market operations, RBI uses other quantitative measures and qualitative measures in conjunction with OMO. Repo Rate, Reverse Repo rate, CRR, SLR, MSF, LTRO. TLTRO etc are other major quantitative credit control tools employed by RBI.
