Previous Year Question
In the context of the Indian economy, ‘Open Market Operations’ refers to:
Borrowing by scheduled banks from the RBI
Lending by commercial banks to industry and trade
Purchase and sale of government securities by the RBI
None of the above
Correct Answer: C
Detailed Solution
Open Market Operations refer to the outright purchase and sale of government securities by the Reserve Bank of India in the open market. RBI primarily uses OMO to inject or absorb durable liquidity in the banking system.
Purchase of government securities by RBI: RBI purchases government securities from banks or other eligible market participants and makes payment for them. This introduces funds and reserve money into the banking system. Consequently, banking liquidity and the capacity of banks to extend credit may increase.
Sale of government securities by RBI: When RBI sells government securities, payment made by purchasers moves from the banking system to RBI. This absorbs surplus liquidity and may reduce the resources available with banks.
The effect of OMO can be summarised as follows:
Purchase of securities → injection of liquidity
Sale of securities → absorption of liquidity
Purchases may increase demand for government securities and place downward pressure on their yields.
Sales may increase the market supply of securities and place upward pressure on their yields.
Option (a) is incorrect. Borrowing by scheduled banks from RBI may occur through the Repo facility, Marginal Standing Facility or other liquidity arrangements. Such borrowing is not an Open Market Operation.
Option (b) is incorrect. Lending by commercial banks to industry and trade is part of normal banking and credit allocation. It is not an open-market transaction undertaken by the central bank.
Government securities used in OMO represent debt obligations of the Central or State Governments. RBI transacts in these securities to manage banking-system liquidity.