OPEN MARKET OPERATIONS (OMO) (Syllabus: GS Paper 3 – Economy)

Context: Recently, discussions on open market operations (OMO) auctions have paused among bond market participants due to the current tightness in banking system liquidity. 

• Anticipation prevails that the system liquidity will remain in deficit mode, at least until mid-December.

Open Market Operations (OMO)

• About: It is an activity by a central bank to give (or take) liquidity in its currency to (or from) a bank or a group of banks.
• Regulate By: Reserve Bank of India
• Participants in OMO: Scheduled Commercial Banks and Financial institutions
• Purpose: Influence money supply, manage interest rates, and achieve monetary policy objectives.
• Types of OMOs
• Outright Purchase (PEMO) involves the permanent selling or buying of government securities.
• Repurchase Agreement (REPO) is a short-term arrangement subject to repurchase.

OMOs vs Liquidity

• When the central bank aims to inject liquidity into the monetary system, it purchases government securities in the open market, thereby supplying liquidity to commercial banks. 
• Conversely, by selling securities, it restricts liquidity, enabling the central bank to indirectly regulate the money supply and impact short-term interest rates.

Importance of OMO

• In India, the second half of the financial year typically witnesses tightening liquidity due to a slowdown in government expenditure and a seasonal increase in currency demand during the festival season.
• Effective liquidity management is crucial to prevent cash shortages for banks and borrowers.
• The central bank's indication of transitioning from a deficit stance to a 'natural' liquidity stance suggests potential increased liquidity in the system.