All you wanted to know about Operation Twist – The Hindu BusinessLine

Since last week, a fascinating code name has been trending on the Internet — Operation Twist. Rolled out by the RBI, this seemingly secretive mission is all set to ignite the bond market — without the use of any fireworks, that is. As the name suggests, this operation was aimed to work like a plot twist. But what is the ‘twist’ all about?

What is it?

Operation Twist is the name given to a monetary policy tool that the US Federal Reserve had initiated to influence the prevailing rate of interest in the markets. The tool essentially aims at changing the shape of the yield curve (hence the name — twist) through simultaneous buying and selling of long- and short-term government bonds. In India, the RBI put through its version of Operation Twist on Monday by buying ₹10,000 crore worth of 10-year government bonds while selling four shorter-term government bonds adding up to the same value. The intent is to moderate high long-term interest rates in the market and bring them closer to the repo rate.

In the US such tactics were first used in 1961, when the economy was recovering from recession post the Korean War. In order to boost spending, the Federal Open Market Committee (FOMC) tried to flatten the yield curve. A flatter yield curve reduces the excess compensation that bond holders earn for the added risk of holding bonds for a longer tenure.

Why is it important?

Despite a cumulative reduction of 135 basis points in India’s policy repo rate since January 2019, banks have effected a decline of just 40-47 basis points in their weighted average lending rates in the same period. Even the mandatory linking of bank lending rates to an external benchmark (including the repo rate) has not helped. With growing concerns over fiscal slippage and rising inflation, the key market interest rate that everyone tracks — the 10-year G-sec yield — rallied to 6.8 per cent last week. Clearly, the MPC decision to pause repo rate cuts didn’t help, with a spike of 33 basis points coming in after the MPC meeting on December 5.

High market yields on the 10-year G-sec influence bank lending rates on vehicle, housing and other long-term loans, hurting retail borrowers. This seems to have prompted the RBI to compensate for its unexpected pause on December 5 with the surprise announcement of Operation Twist. Though the amount of securities bought/sold on December 23 was only worth ₹10,000 crore, the bond markets still welcomed it with a big cheer. This was in anticipation of several such announcements in future. Post the announcement, the 10-year G-sec yield dropped by 20 basis points on intra-day trade to 6.6 per cent while the yields on shorter tenure bond (five year) rose 16 basis points to 6.67 per cent, making for a flatter yield curve. That also helps bring down borrowing costs for the government.

Why should I care?

If you’re a fixed income investor sitting on a debt-heavy portfolio, softening yields of long-term bonds may help your portfolio get back into the green. There is good news in store for consumers/borrowers as well. The high yields on long-term government borrowings had led to banks pricing their retail loans at high rates. These loans can now be expected to get slightly cheaper with Operation Twist. Cheaper retail loans can boost consumption spending which accounts for a good chunk of the GDP.

The bottomline

Santa may have arrived early for bond holders with Operation Twist. But if there’s an overshoot in the inflation and deficit numbers, you may need to watch out for other twists in this tale.

via All you wanted to know about Operation Twist – The Hindu BusinessLine

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