Earlier this week, India’s Central bank, the RBI (Reserve Bank of India), announced that in an effort to mop up excess liquidity from the economy it would soon be initiating sale of Government bonds worth INR 12,000 crore. The RBI statement said, “On an assessment of current and evolving liquidity conditions, Reserve Bank has decided to conduct sale of Government securities under Open Market Operations for an aggregate amount of Rs 12,000 crore on December 1 through multi-security auction using the multiple price method”. The Government bonds are to be sold by the RBI under its Open Market Operations (OMO).
It is now believed that under these OMO sales, the RBI will offload Government securities which shall mature in the years 2017, 2020, 2022, and 2027. These bonds shall fetch the investors an interest rate of 8.07 percent, 7.8 percent, 8.8 percent, and 8.26 percent, respectively. While the RBI has announced that the ceiling for the overall sale is “12,000 crore for all the securities in the basket put together”, the quantity of sale for each individual bond is yet to be decided. The Central bank, however, will also retain the option to accept bids that do not make the aggregate figure (INR 12,000 crore).
What are Open Market Operations?
Open Market Operations is the sale or purchase of Government securities in the open market, typically undertaken by the country’s Central bank – in our case the RBI. These Government securities are bought and sold by the RBI to regulate the amount of money in the banking system. The expansion or contraction of the amount of money in the banking system plays an important role in regulating growth and curbing inflation. The RBI’s intended inflation target for January 2015 is about 8 percent and 6 percent for January 2016. In achieving this target, the RBI’s open market operations may play an important role.
Latest inflation figures
India’s annualized Consumer Price Index (CPI) inflation rate has eased to 5.5 percent in October – the lowest it has been since India started computing the CPI in January 2012. This dip, down from over 11 percent a year ago, is phenomenal and the success is attributed to the policies put in place by the RBI Governor, Raghuram Rajan, who took over as the chief of India’s Central bank in September 2013. So much so that Rajan was named 2014 Best Central Bank Governor by Euromoney for his efforts and achievements. India’s wholesale inflation in October also dipped to a five-year low largely due to the decline in food and fuel prices.
The economy’s Wholesale Price Index (WPI) inflation rate also declined to about 2.38 percent (September data) from the same month last year – the lowest increase in about 5 years. While traditionally the Wholesale Price Index (WPI) has been primarily used to measure inflation, the stress moved to the CPI rates with Rajan’s appointment at the RBI. His preference for the CPI comes from the fact that most developed countries such as the US use the CPI index. CPI rates are a more accurate measure of the country’s inflation in the context of its monetary policy.
Are rate cuts likely?
Despite the decline of retail inflation even beyond the RBI’s January 2016 target, Rajan has resisted all pressure to cut down on the RBI’s repo rate. The fear that disturbing this may trigger inflationary trends once more has prevented the RBI from cutting down on bank rates despite demand from India Inc. The markets are of the view that Finance Minister Arun Jaitley is likely to convince the RBI to cut down benchmark interest rates on December 2 when the next policy review comes up. Lower borrowing costs will initiate a new spurt of growth, the traders believe.
Is the RBI winning yet?
A number of economists have been predicting that the RBI rates will remain unchanged until the end of 2015. While Rajan is continuing to monitor inflation closely, he will certainly have a tough time convincing the Finance Ministry that inflation is still a threat to the economy. Much of the dip in inflation can be attributed to the drastic fall in oil prices and the Ukraine and Middle East conflict are likely to reinforce the inflation threat with a weakening rupee. While the RBI, under a very hawkish Rajan has been successful in exceeding targets when it comes to inflation control, it remains to be seem how the influence of India Inc. and the Finance Ministry plays out in the current scenario.
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