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Open market operations is a measure used by the central bank of the country to manage money supply. Through OMOs, central bank either purchase or sell government bonds in the open market. The primary tool for implementing monetary policy, OMOs facilitate changes in short-term interest rates and money supply depending on the prevailing economic scenario.
In case, the liquidity condition of the economy is weak, the central bank purchases government securities and hence infuses money into the system. Otherwise, it sells securities in case of excess liquidity in the system.
The central bank performs open market operations considering the targets for various economic parameters such as interest rates, exchange rates or inflation. Also, the measure is used as a tool for Open Market operations in India
Open Market operations in India
Before, the financial reforms of 1991, cash reserve ratio (CRR) and statutory liquidity ratio (SLR) were the prime tools used by the central bank to control money supply and interest rates in the market. But soon, both the parameters lost their importance and implementation of open market operations scaled immensely as OMOs are deemed comparably effective in correcting market liquidity.
The Reserve Bank of India in India performs OMO in two ways :
1. Outright Purchase (PEMO): Through PEMO, RBI out-rightly engages in purchasing and selling of securities for expanding or contracting the money-supply for a long-term.
2. Repurchase Agreement ( REPO): RBI through REPO engages in securities sale or purchase with a condition to repurchase.
Open market operations are subdivided into two tactics:
♦ Temporary OMOs: usually deployed to address reserve needs in a transitory state. Implementing this policy involves short-term repurchase and reverse repurchase agreements, which are used to temporarily increase or decrease the size of the Federal Reserve’s System Open Market Account (SOMA) and influence the direction of the federal funds market.
♦ Permanent OMOs: usually deployed to adjust for longer-term factors affecting the Federal Reserve’s balance sheet, or the amount of currency in circulation. Permanent OMOs involve the sale or purchase of securities (again, typically Treasury bonds) in order to increase or decrease SOMA.