Open market operations

Also called: OMO · Topic: Banking, Credit Creation and Monetary Policy · NCERT: Class 12, Ch 3 "Money and Banking"

Meaning

Open market operations (OMO) are when the central bank buys or sells government securities (G-secs, i.e. government bonds) in the open market, to add or remove money in the banking system.

• OMO purchase: the RBI buys bonds and pays banks cash. Bank reserves (the cash banks hold) rise. This is an injection of liquidity (ready cash in the banking system).
• OMO sale: the RBI sells bonds and banks pay it cash. Bank reserves fall. This is an absorption of liquidity.

OMO matters because it changes how much money banks have for lasting periods. That affects how much they can lend and how easily the RBI can keep short-term interest rates near its policy rate.

Explanation

How it works

• OMO purchase (expansionary, meaning it adds money)
• The RBI buys G-secs from banks.
• The RBI pays for them by crediting the banks' accounts with the RBI.
• Banks now hold more reserves, so they can lend more.

• Money supply rises.

• OMO sale (contractionary, meaning it takes money out)

• The RBI sells G-secs to banks.
• Banks pay the RBI from their reserves.
• Banks have less cash to lend.

• Money supply falls.

• Effect on bond prices and yields (textbook link)

• When the RBI buys bonds, demand for bonds goes up, so bond prices rise. The yield (the return a buyer earns on the bond) falls, so market interest rates tend to fall.
• When the RBI sells bonds, bond prices fall. Yields rise, so market interest rates tend to rise.

Types of OMO

• Outright OMO: a permanent purchase or sale, with no promise to reverse it.
• The RBI calls it "outright purchase/sale of government securities… for injection/absorption of durable liquidity" [5].

• Durable liquidity means liquidity that stays in the system for a long time.

• Repo-type operations are the temporary version. The RBI buys securities and the bank promises to buy them back later. The effect reverses when the term ends. These are covered under the repo rate.

Worked example: OMO and credit creation

• The RBI makes an OMO purchase of ₹100 crore of G-secs from banks.
• Bank reserves rise by ₹100 crore.
• Simple money multiplier = 1 / CRR. This ignores SLR and cash held by the public.
• With CRR at 3% (after the 2025 cuts) [4], the multiplier = 1/0.03 ≈ 33.3.
• So ₹100 crore of fresh reserves can support about ₹3,333 crore of deposits.

• At the earlier CRR of 4%, the multiplier was 25, so the same ₹100 crore would support only ₹2,500 crore.

• An OMO sale of ₹100 crore works the other way. Reserves fall, and the possible deposits shrink by the same multiple.

What decides whether the RBI buys or sells

• Liquidity is short (for example, banks keep borrowing at the ceiling rate) → the RBI makes OMO purchases.
• Too much liquidity or rising inflation → the RBI makes OMO sales to take out extra cash.
• The goal is to keep the call rate close to the repo rate. The call rate is the rate at which banks lend to each other overnight.

In India

• Who conducts it: the Reserve Bank of India (RBI), set up in 1935. OMO is one of its quantitative tools. These are general tools that change the total amount and cost of credit and do not target any one sector.
• Legal objective it serves: under the RBI Act preamble (amended in 2016), the aim is "to maintain price stability while keeping in mind the objective of growth" [5].

• The inflation target is CPI 4%, with an upper limit of 6% and a lower limit of 2%. It was renewed on 25 March 2026 for 1 April 2026 to 31 March 2031 [5].

• Operating target: the RBI tries to keep the weighted average call rate (WACR) close to the repo rate. It does this by adding or taking out liquidity [5]. OMO is its tool for durable changes. The repo and SDF windows under the Liquidity Adjustment Facility (LAF), the RBI's daily system for adding and taking out liquidity, handle day-to-day changes [2].

• The rate corridor OMO supports (August 2026) [2]:
• SDF (floor) 5.00% < Repo 5.25% < MSF / Bank rate (ceiling) 5.50%.

• The MPC held the repo rate at 5.25% with a neutral stance in August 2026 [2].

• Link to the SLR: banks must keep 18% of NDTL (verify current) in liquid assets such as G-secs. NDTL (Net Demand and Time Liabilities) is broadly a bank's deposits minus what it holds with other banks. So banks already hold a large stock of G-secs, which gives OMO a deep market of bonds to trade in.

Don't confuse with

• Repo rate / repo operations: repo is a temporary injection for overnight, 7 or 14 days, and it reverses when the term ends. Outright OMO changes liquidity permanently.
• Cash Reserve Ratio (CRR): the CRR changes the required share of NDTL that banks must keep with the RBI (RBI Act s.42). OMO changes the actual amount of reserves banks hold, without changing any ratio.
• Statutory Liquidity Ratio (SLR): under the SLR, banks must hold G-secs themselves (Banking Regulation Act s.24). In OMO, the RBI buys or sells G-secs to move liquidity.
• Reverse repo / SDF: these absorb liquidity overnight or for short periods at a fixed floor rate. An OMO sale absorbs liquidity durably.

Prelims Hooks

• OMO purchase → liquidity injected → money supply rises. OMO sale → liquidity absorbed → money supply falls. A common trap is to reverse the direction.
• Outright OMO means a permanent change in durable liquidity [5]. Repo is temporary (overnight, 7-day or 14-day).
• OMO is a quantitative (general) tool, not a qualitative (selective) one like margin requirements or moral suasion.
• OMO is carried out in government securities, not in company shares or company bonds.
• The RBI's operating target is the WACR, not the repo rate itself. OMO helps keep the WACR close to the repo rate [5].
• Simple money multiplier = 1/CRR. With CRR at 3% (2025) [4], ₹100 of OMO-injected reserves can support about ₹3,333 of deposits.

Mains Points

• Liquidity management versus the policy signal: the repo rate signals the price of money. OMO decides the lasting quantity of money.
• If the RBI cuts the repo rate but the system stays short of cash, loan rates may not fall.

• OMO purchases, along with the 100 bps CRR cut in 2025 [4], supply lasting funds. This helps a rate cut actually reach borrowers.

• Link with government borrowing (fiscal-monetary interface):

• When the RBI buys G-secs, bond yields fall and government borrowing becomes cheaper.
• If this is done too often, it can look like the central bank is funding the government. That can weaken inflation control.

• The rule-based framework (s.45ZA target, s.45ZB MPC) is meant to keep monetary policy separate from fiscal pressure [5]. This is relevant for GS-II (statutory bodies and their independence).

• Inflation versus growth trade-off: after a 250 bps hike in 2022-23 and a 125 bps cut in 2025, the RBI held the repo rate at 5.25% with a neutral stance in 2026 [2][3].

• Large OMO purchases at such a time could push extra cash into the system and bring inflation back.
• Large OMO sales could make credit tight and slow growth.
• So the size and timing of OMO must match the policy stance.

Related concepts

• Monetary policy
• Expansionary monetary policy
• Contractionary monetary policy
• Quantitative tools of monetary policy
• Cash Reserve Ratio
• Net Demand and Time Liabilities
• Statutory Liquidity Ratio
• Bank rate
• Outright open market operations
• Repo rate

Read more

• Monetary policy and its quantitative instruments