Open market operations consist of buying and selling of government securities by the Reserve
Bank. Open market operations have a direct effect on the availability and cost of credit. When the central
bank purchases securities from the banks, it increases their cash reserve position and hence, their
credit creation capacity. On the other hand, when the central bank sells securities to the banks, it
reduces their cash reserves and the credit creation capacity. The Reserve Bank of India did not
rely much on open market operations to control credit. It was not used for influencing the availability
of credit. Due to under-developed security market, the open market operations of the Reserve Bank
are restricted to Government securities. These operations have also been used as a tool of public
debt management. They assist the Indian government to raise borrowings.
The open market operations of the Reserve Bank has not been so effective because of the following
reasons:
(a) Open market operations are restricted to government securities.
(b) Gift-edged market is narrow.
(c) Most of the open market operations are in the nature of “switch operations” (i.e., purchasing one loan
against the other).
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’.
Repurchase Agreements (Repo):
Repurchase Agreements which are also called as Repo or Reverse Repo are short term loans
that buyers and sellers agree upon for selling and repurchasing. Repo or Reverse Repo transactions can be
done only between the parties approved by RBI and allowed only between RBI-approved securities such as
state and central government securities, T-Bills, PSU bonds and corporate bonds. They are usually used
for overnight borrowing.
Repurchase agreements are sold by sellers with a promise of purchasing them back at a given
price and on a given date in future.
Money Market Instruments:
Money Market Instruments provide the tools by which one can operate in the money market.
Money market instrument meets short term requirements of the borrowers and provides liquidity to the
lenders. The most common money market instruments are Treasury Bills, Certificate of Deposits,
Commercial Papers, Repurchase Agreements
Treasury Bills (T-Bills):
Treasury Bills are one of the safest money market instruments as they are issued by
Central Government. They are zero-risk instruments, and hence returns are not that attractive. T-Bills
are circulated by both primary as well as the secondary markets. They come with the maturities of
3-month, 6-month and 1-year. The Central Government issues T-Bills at a price less than their face value
and the difference between the buy price and the maturity value is the interest earned by the buyer of
the instrument. The buy value of the T-Bill is determined by the bidding process through auctions.
At present, the Government of India issues three types of treasury bills through auctions, namely,
91-day, 182-day and 364-day.
Certificate of Deposits (CDs):
Certificate of Deposit is like a promissory note issued by a bank in form of a certificate
entitling the bearer to receive interest. It is similar to bank term deposit account. The certificate bears the
maturity date, fixed rate of interest and the value. These certificates are available in the tenure of 3 months
to 5 years. The returns on certificate of deposits are higher than T-Bills because they carry higher level
of risk.
Commercial Papers (CPs):
Commercial Paper is the short term unsecured promissory note issued by corporates
and financial institutions at a discounted value on face value. They come with fixed maturity period ranging
from 1 day to 270 days. These are issued for the purpose of financing of accounts receivables, inventories
and meeting short term liabilities.
The return on commercial papers is is higher as compared to T-Bills so as the risk as they are less
secure in comparison to these bills. It is easy to find buyers for the firms with high credit ratings. These
securities are actively traded in secondary market.
