Methodology of Operation Twist

Methodology of Operation Twist

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• As part of Operation Twist, the Central Bank simultaneously purchases and sells short-term bonds. Therefore, the purchase of long-term bonds is made with the proceeds from the sale of short-term securities without the need for additional funds.

• The long-term yields in India determine the interest rate for long-term borrowings. The aggregate demand is created by these long-term borrowings.

• The amount of interest paid to investors is known as bond yield. • There is an inverse relationship between bond prices and yield. The formula for calculating bond yield is = Annual Coupon Payment / Face value of the Bond. For instance, if bond prices rise, so does the yield, and vice versa.

• The demand for long-term bonds rises in tandem with an increase in bond prices as central banks acquire them. The yield on bonds decreases when bond prices rise.

• A lower yield encourages lower interest rates and lower borrowing costs, thereby increasing economic aggregate demand.

• As a result, the average person's focus shifts from saving to spending, causing aggregate demand to spiral upward.

• This also lowers the expected returns from long-term savings.

Therefore, as part of its operation twist, the RBI sells short-term securities on the market, bringing public funds to the bank. RBI purchases long-term government securities with the money it receives, reducing the supply of long-term government securities. As a result, both yield and price rise as a result of high demand and limited supply of securities. The yield goes down whenever bond prices rise. As a result, the goal is to reduce the supply of long-term securities and raise the price of long-term securities (high bond price). In the past, the RBI was also lowering the repo rate, but at the same time, the yield was rising, which made the gap wider. The gap narrowed as a result of the low yield, prompting the commercial bank to lower interest rates, which in turn led to an increase in consumption. Since commercial banks also provide long-term loans, raising the price of long-term security has emerged as the most effective strategy for lowering interest rates.