What is RBI's Operation Twist and how does it affect investors?

The Reserve Bank of India will hold the second round of 'Operation Twist' on Monday (December 30). The first lap of this operation was launched by the central bank on December 23 with an aim to increase long term investment in the country.

But what does 'Operation Twist' mean, let's take a look.

What is 'Operation Twist'?

'Operation Twist' is RBI's simultaneous selling of short-term securities and buying of long term securities through open market operations (OMO). Under this mechanism, the short-term securities are transitioned into long-term securities.

Whenever there is a long-term investment deficit in the country and the investors are hesitant to make long-term investments in the economy, the government jumps in to revive growth by lowering the interest rate for long-term investment ventures.

How does RBI manage 'Operation Twist'?

RBI carried out the first phase of 'Operation Twist' on December 23, 2019, when it sold short-term securities worth Rs 10,000 crore and bought long-term securities worth the same value. This operation involves buying and selling government securities simultaneously in order to bring down long-term interest rates and bolster short-term rates.

There is an inverse relationship between the bond prices and their yields. As the central bank buys long-term securities (bonds), their demand rise which in turn pushes up their prices.

However, the bond yield comes down with an increase in prices. Yield is the return an investor gets on his (bond) holding/investment.

The interest rate in an economy is determined by yield. Thus, lower long-term interest rates mean people can avail long-term loans (such as buying houses, cars or financing projects) at lower rates.

This also results in a dip in the expected returns from long-term savings which tilts the balance from saving towards spending. Hence, cheaper retail loans can help encourage consumption spending which is the largest GDP component in the economy.

How does it affect investors?

Fixed income investors with higher exposure to long term debt will benefit from easing yield of long-term bonds. Consumers/borrowers will also profit from 'Operation Twist' as the retail loans will now get cheaper. Previously banks were forced to price their retail loans at higher rates owing to high yields on long-term government borrowings. Cheaper retail loans mean a boost in consumption and spending in the economy which in turn will revive growth.

What's behind the name?

The term 'Operation Twist' is an Indian version of unconventional measures taken by the US Federal Reserve in 2011 in its bid to boost economic growth after getting hit by the global financial crisis.

The moniker, however, is derived from American rock 'n' roll singer Chubby Checker's hit song, "The Twist" in the early 1960s when the US economy was recovering from recession post the Korean War (in 1961).

In its bid to promote spending, the John F. Kennedy administration lowered long-term borrowing and spurred bank lending. Hence, it named this maneuver 'Operation Twist' whereby the Federal Bank first sold short-term securities and then purchased long-term securities with that money.

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