Open Market Operations

OPEN MARKET OPERATIONS :-

OMOs are the market operations conducted by the Reserve Bank of India by way of sale/ purchase of Government securities to/ from the market with an objective to adjust the rupee liquidity conditions in the market on a durable basis. When the RBI feels there is excess liquidity in the market, it resorts to sale of securities thereby sucking out the rupee liquidity. Similarly, when the liquidity conditions are tight, the RBI will buy securities from the market, thereby releasing liquidity into the market. Open market operations refer to the purchase and sale of securities by the central bank. In its broader sense, the term includes the purchase and sale of both government and private securities. But, in its narrow connotation, open market operations embrace the purchase and sale of government securities only. It was in Germany that open market operations took its birth as an instrument of quantitative credit control.

Theory of Open Market Operations:-

The theory of open market operations is that by the purchase and sale of securities, the central bank is in a position to increase or decrease the cash reserves of the commercial banks and therefore increase or decrease the supply of credit in the economy.

During a period of inflation, the central bank seeks to reduce the supply of credit in the economy. Hence, it sells the securities to the banks, public and others. As a result of the sale of securities by the central bank, there will be a transfer of cash from the buyers to the central bank. This will reduce the cash reserves of the commercial banks. The public has to withdraw money from their accounts in the banks to pay for the securities purchased from the central bank. And the commercial banks themselves will have to transfer some amount to the central bank for having purchased the securities. All this shrinks the volume of cash in the vaults of the banks. As a result the banks will be unable to expand the supply of credit. When the supply of credit is reduced by the banking system, the consequences on the economy will be obvious. Investment activity is discouraged ultimately leading to a fall in the price level. 

On the other hand, during a period of deflation, in order to inject more and more credit in to the economy, the central bank purchases the securities. This will have an encouraging effect on investment because the banks supply more credit following an increase in their cash reserves. Thus, the central bank seeks to combat deflation in the economy.

Objectives of Open Market Operations:-

The main objectives of open market operations are:

(a) To eliminate the effects of exports and imports to gold under the gold standard.

(b) To impose a check on the export of capital.

(c) To remove the shortage of money in the money market.

(d) To make bank rate more effective.

(e) To prevent a ‘run on the bank’.