Is it time for India’s own version of the US Fed’s Operation Twist?

Niranjan Rajyadhaksha’s new piece in Mint asks whether India needs to do its version of Operation Twist:

The Indian central bank has been expanding its balance sheet to create durable liquidity in the money market. The initial focus was on bond buying through open market operations, since foreign exchange inflows were weak till recently. The revival of foreign exchange inflows over the past few weeks gives RBI space to also buy dollars to create domestic liquidity. The $5 billion swap—where the central bank will give banks rupees in exchange for the dollars they bring in—is nothing but an attempt to boost domestic liquidity. This swap is similar to the one announced in 2013 to defend the rupee. The difference this time is that there is no macro stress on the horizon.

Much of the action has till now been restricted to the short end of the money market. The Indian central bank has been less successful in dealing with yields on bonds with longer maturity. The problem is that the heavy borrowing by the government, combined with a revival in bank credit growth, is putting upward pressure on interest rates despite the anticipated reductions in policy rates. The domestic yield curve has been steepening because of what one economist described to me as “fiscal fatigue” in the markets.

One option right now is to borrow a trick from the US Federal Reserve—Operation Twist, named after the dancing style that was all the rage in the years after World War II. There have been two famous instances when the US central bank “twisted” a steep yield curve through clever money market operations, first in 1961 and then in 2011. In each case, the Fed changed the relative amounts of short-term and long-term securities in the market. How? It sold the short-term treasuries it had and used the proceeds to buy long-term securities. The result was that short-term interest rates went up while long-term interest rates came down. The yield curve flattened.

Photo: Alamy

Economists have been torn between two camps over the success of the first Operation Twist. In a paper published in February 2011, Eric Swanson of the Federal Reserve Bank of San Francisco argued that the 1961 operation had a statistically significant effect on long-term bond yields once high frequency rather than quarterly data was used. His delightfully titled paper, Let’s Twist Again: A High-Frequency Event-Study Analysis Of Operation Twist And Its Implications For QE2 (, was one piece of empirical evidence used to justify the second Operation Twist launched six months later. The RBI is doing a form of quantitative easing by expanding its balance sheet. The yield curve remains steep. Is it time for its own version of Operation Twist?



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