Tenets and Concept of Operation Twist

Tenets and Concept of Operation Twist

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The Central Bank's unconventional monetary policy is known as Operation Twist. In India, the Reserve Bank of India recently tried "Operation Twist." The monetary policy operation run by the US Federal Reserve was originally referred to as "Operation Twist." In order to boost the economy by lowering long-term interest rates, this operation involved the purchase and sale of government securities. The Reserve Bank of India carried out its version of "Operation Twist" in 2019 and 2020 by using Open Market Operations (OMOs) to simultaneously purchase and sell government securities.

The Reserve Bank of India manipulates the "Yield of government securities" through an operation known as "Operation Twist", particularly the yield of long-term government securities in comparison to short-term government securities. The RBI will buy long-term government bonds and sell short-term government securities as part of Operation Twist. The yield of long-term securities will be lower than that of short-term securities if you buy long-term securities and sell short-term securities. Operation Twist aims to achieve this Yield impact.

The benefit or interest rate of a Government Security, such as: Treasury Bills or Government Bonds) provide. For instance, a Government Bond worth Rs. 1000 pays Rs. 100 in annual interest and has a Yield of 10%. The market will be in high demand if the RBI purchases long-term government bonds in bulk. Long-term bonds' prices will rise as a result. The Yield, or interest rate, of long-term bonds decreases when bond prices rise. This is due to the bonds' inverse relationship between their yield and price. Therefore, the RBI can lower the interest rates of long-term government securities by simultaneously purchasing long-term bonds and selling short-term securities.

The reduction of the interest rate on long-term government securities is the goal of operation twist. Let's say that long-term government securities with an initial price of Rs. 1000 yielded 10% prior to Operation Twist. There is a significant demand for this long-term bond now that the RBI is buying it in bulk. The price will rise in tandem with the rise in demand. Imagine that the price of the government bond on the secondary bond market rises to Rs. 1200. This indicates that individuals are willing to sell the bond at a higher price.

Now, if someone buys this bond, he or she will only receive a 10% interest rate on the original price of Rs. 1000, or Rs. 100 per year in interest. The new proprietor of the bond spent Rs 1200, yet he will get an interest of Rs 100 and not Rs.120. What does it imply? The bond's effective interest rate has decreased. The yield on the bond has decreased to just 8.3% from the initial rate of 10%. Rs.100 gain for a Rs.1200 venture is 8.3%. Even though the initial interest rate was 10%, the yield decreased with bond price. This is just one perspective. When the government sells short-term securities, the opposite takes place. The RBI can thus lower long-term interest rates by simultaneously buying and selling government securities (Operation Twist).