Sussing ‘Stances’ & ‘Operation Twist’

RBI’s terminologies have been replete with jargons. Remarkably, last year, the bureaucrat-turned governor left spectators scrambling for dictionary, to decode his speech. The governor mentioned an infinitely augmented word in the language – “Floccinaucinihilipilification”. Usage of jargons have become enshrined in RBI’s modus-operandi, indeed. The article demystifies a handful of such jargons.

Decoding RBI’s Policy Stances:

The RBI publishes a policy stance during its bi-monthly MPC (Monetary Policy Committee) congregations. The Stance is supposed to foretell the direction of interest rate movements. The stance also has substantive impact in controlling currency gyrations in the short-term. Stances have three-tier classifications, namely-

  • Accommodative stance: Adopted at times of economic impasse, as in the prevailing scenario. The adoption of accommodative stance stands as a precursor for further rate-cuts. Albeit, exceptional circumstances have drifted movement to the contrary, disregarding the stance. To regear economic growth, funds ought to be cheaper. Accommodative stance is rejoiced by the debt-market. As rates nosedives, yield on debt follows the trajectory. Prices of the bonds move up, as yield negatively varies with bond prices. There’s a spontaneous surge in NAV (Net asset Value) of debt mutual fund. The concept of “Modified Duration” – by Macaulay seems pragmatic here. For instance, a bond with a modified duration of 4, will surge by 4% for every 1% cut in rate. However, sustaining accommodative stance over periods catalyses inflation in the economy. Growth & inflation are akin to twin eyes of a human. The eyeballs have to be aligned, for picture-perfect vision. Similarly, growth & inflation have to be synchronous, well within ballparks.             
  • Neutral Stance: The reason behind such a stance is questionable till date. At any circumstance, the RBI has the leeway to alter the rates, in either direction, at its discretion. So why adopt a stance for it?? Neutral stance stands applicable implicitly, even when other stances have been adopted. Neutral stance suggests that the rates can move in either direction or even stay put. By adopting neutral Stance, the RBI says “We reserve comment on rate movements”, in my opinion.
  • Calibrated Tightening:  The prefix to tightening means “careful”. Is tightening stance alone calibrated?? So, the RBI is not calibrated in adopting accommodative / Neutral stance? The usage of the prefix “calibrated” remains a mystery till date. Calibrated tightening is adopted in circumstances when inflation is no longer benign and when rupee tends to reach new lows. By hiking rates, there’s an implicit shortage / deficit in money supply created, which will in turn curb spending & inflation.

Any stance is always interim. No government can continue with a stance for more than a stipulated period. Periods of “accommodative stances” foster growth and inflation. To extenuate the later “Calibrated tightening” is adopted. Eventually, growth in the economy gets hit, unemployment and deflation get upped. Again, the stance gets changed to “accommodative”. When the effects of the rate cuts are not felt in the economy, periods of “Neutral stance” props up, giving additional time for the economy to absorb the benefits (rate-cuts). The cycle keeps on repeating, ceaselessly.

Interestingly, when governments expect spontaneous effects of the rate alterations, a sophisticated moved “Operation Twist” is adopted.

What’s the necessity for an “Operation twist”?? A lynchpin indicator of a bank’s performance is its “NIM” (Net Interest Margin) – which is the spread / difference between interest earned on loans & paid on deposits. At times of rate cuts, banks mull about passing on the rate cuts to the public. Astutely, deposit rates will be cut, but not lending ones! To improve their NIM. Eventually, the RBI’s objective of fostering growth in the economy gets hit. Sometimes, bond markets take ample time to digest rate cuts, ergo yields stay put. To expedite the effects of a rate-alteration move – “operation twist” is carried out.

What happens in “Operation twist”?? Operation twist is akin to a “non-cash” item in cash-flow parlance. The effect of operation twist on the cash / money supply in the economy is null. The government stimulates the demand for short term / long term bonds, thereby affecting their prices and yields. For instance, to alleviate immediate liquidity issues in the economy, short term loan rates require a slash. It might consume considerable time to feel the impact through banks. To circumvent delay, RBI purchases short term bonds (ex. G.Sec maturing in a year) from the open market, thereby stimulating the demand for short term bonds. The effect of which is a hike in price and fall in bond yields. Hence, its objective of bringing down short-term borrowing rates stands achieved.

What is the source of funds for “Operation twist”?? As previously mentioned, the effect on money supply in the economy is not affected because of the operation. For instance, if the RBI buys short term bonds, to recompense, it sells an equivalent amount of long-term bonds and vice-versa.

The origin of ‘operation twist’ dates back to 1961, initially conducted by Federal reserve – during the reign of then president, John F Kennedy. India’s maiden operation twist was conducted during December 2019. We can expect more “operation twists” in India, up until, the light at the end tunnel called Covid is found.

-Arunachalam Sivaraman

Published by adithyaarunachalam

I'm a millennial, from Chennai, India. Passionate about building up a career in finance, I follow and stay abreast on news feeds. I'm a novice blogger, So feel free to pass on your conjecture to me @adithyaarunachalam@Gmail.com

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