Yield and prices of a bond move in opposite directions.
OMO, as a tool, has at least a three-fold impact.
Many Faces Of OMO
Draining liquidity from the system or infusing liquidity is just one of the three purposes that OMO serves
It is also a yield-management tool. When bonds are sold through OMOs, in addition to the regular auctions for government securities in accordance with the borrowing calendar, it increases the supply of bonds in the market. As a result of this, it can push the bond yield up.
The third objective an OMO sale could achieve is addressing the slippage in local currency.
If the OMO sale pushes up the government bond yield, the spread between US and Indian bond yields will widen. It has been shrinking.
As the spread or the difference between the Indian and US bond yields shrinks, foreign money flow into India slows down; the investors find US bonds more attractive and, consequently, the local currency comes under pressure. The OMO sale will address the rupee depreciation against the dollar.
Time and again, RBI Governor Shaktikanta Das has reiterated that the Indian central bank wants to bottle the inflation genie at 4 per cent for good and not 6 per cent — the upper limit of the inflation target. Lower liquidity, higher bond yield and improved capital flows will help the rupee as well as fight against inflation.
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