Open Market Operations

Introduction

• Open Market Operation (OMO) is the sale and purchase of government securities in the open market by the Reserve Bank of India (RBI). 
• The principal goal of the OMO is to regulate the economy’s money supply. 
• OMO is one of the tools that RBI uses to smoothen the liquidity conditions through the year and minimize its impact on the interest rate and inflation rate levels.

How is Open Market Operation conducted?

• RBI carries out the OMO through commercial banks and does not directly deal with the public.
• When the RBI wants to increase the money supply in the economy, it purchases the government securities from the market and it sells government securities to suck out liquidity from the system.
• It alters the proportion of securities owned by the RBI and commercial banks while keeping the overall stock of securities constant. 

Difference between Liquidity Adjustment Facility (LAF) and OMO

Importance of OMO

• In India, liquidity conditions usually tighten during the second half of the financial year. This happens because the pace of government expenditure slows down, even as the onset of the festival season leads to a seasonal spike in currency demand.
• Liquidity management is also essential so that banks and their borrowers don’t face a cash crunch. The central bank’s signal that it will move to a ‘natural’ liquidity stance from a deficit stance, hints at more liquidity in the system in future. This could arm banks with more funds for lending and lead to softer interest rates in the economy (Loans with lower interest rates). However, large open market purchases by the RBI can give the government a helping hand in its borrowing programme and are frowned upon for this reason.