Operation Twist

Also called: Simultaneous OMO purchase and sale · Topic: Banking, Credit Creation and Monetary Policy · NCERT: Beyond NCERT

Meaning

Operation Twist is a central bank tool in which the central bank buys long-term government securities and sells short-term government securities at the same time. The aim is to lower long-term yields (the interest a bond pays) without changing overall liquidity (the total money in the banking system).

• It matters because long-term yields decide the cost of home loans and company borrowing. Operation Twist lets a central bank make these loans cheaper without adding new money, so there is less risk of higher inflation.
• Formula: Net liquidity added = Value of long-term securities bought − Value of short-term securities sold ≈ 0

Explanation

Why central banks need it

• Conventional monetary policy means changing the short-term policy rate. In India this is the repo rate (the interest rate at which the RBI lends money to banks for a short time).
• The limit: the policy rate controls short-term rates well. But it may not bring down long-term rates, which are the rates that matter for investment.

• When this happens, transmission breaks. The policy rate changes, but loan and bond rates do not follow.

• Unconventional monetary policy means any tool beyond changing the short-term policy rate. It usually works through the central bank's balance sheet (what it owns and what it owes).

• Operation Twist is one of these tools. It does not change the size of the balance sheet. It changes the mix of what the central bank holds, from short-term securities to long-term ones.

How it works: two legs at the same time

• Leg 1: buy long-term securities
• The central bank buys long-term bonds → bond prices rise → long-term yields fall.

• Bond prices and yields always move in opposite directions.

• Leg 2: sell short-term securities

• The central bank sells short-term bills → money comes back to the central bank.
• This cancels out the money it paid for the long-term bonds.

• More short-term paper in the market can push short-term yields up a little, or at least stops them from falling.

• The result: the yield curve "twists"

• Yield curve: a line that shows the interest rates on bonds of different maturities, for example 1-year, 5-year and 10-year.

• The long end falls and the short end stays flat or rises slightly. The curve becomes flatter, as if it has been twisted.

• Why liquidity stays the same: the money paid out for the purchases comes back in through the sales.

Worked example

• The central bank buys ₹10,000 crore of 10-year bonds. It sells ₹10,000 crore of 6-month bills.
• Net money added = ₹10,000 crore − ₹10,000 crore = ₹0.
• The total money in the system does not change. But the extra demand for 10-year bonds pushes their price up, so the long-term yield falls.

History

• US Federal Reserve: used Operation Twist in 1961 and again in 2011-12.
• RBI: its version is the special OMO (December 2019 - 2020).

In India

• Institution: the Reserve Bank of India (RBI) runs it through open market operations (OMOs).

• OMO: the RBI buys or sells government securities (G-secs) in the market to add money to the system or remove it.

• India's name for it: "Special OMO"

• A special OMO is a simultaneous purchase of long-dated G-secs and sale of short-dated securities.
• Period: December 2019 - 2020.

• Aim: bring down long-term yields, and so long-term borrowing costs, without adding extra liquidity.

• Example tranche (auction on 3 September 2020): ₹20,000 crore in total, in two tranches of ₹10,000 crore each [1].

• Bought: 7.72% GS 2025, 6.79% GS 2027 and 5.79% GS 2030.
• Sold: 182-day Treasury Bills maturing in October-November 2020 [1].

• What this shows: the RBI bought bonds maturing years later and sold bills maturing within weeks. That is the "twist".

• Where it fits in India's approach:

• India never went to a zero or negative policy rate. The RBI used softer, India-sized versions of global tools, mainly during 2019-21.
• Special OMOs were used alongside G-SAP (2021) and TLTROs (2020). Together they lowered long-term yields but avoided open-ended QE and direct deficit monetisation.

Don't confuse with

• Quantitative easing (QE): QE buys bonds with newly created money, so liquidity and the balance sheet grow. Operation Twist buys and sells at the same time, so net liquidity is unchanged.
• Yield curve control (YCC): YCC announces a target yield for a specific bond, such as the BoJ's target for the 10-year JGB (2016-24), and buys as much as needed to hold it. Operation Twist swaps a set amount of securities and has no yield target.
• Quantitative tightening (QT): QT shrinks the balance sheet by selling assets or letting bonds mature without reinvesting, which takes money out and pushes long-term yields up. Operation Twist keeps the balance sheet size the same and pushes long-term yields down.
• G-SAP (2021): G-SAP was a one-way, pre-committed purchase of G-secs (₹2.2 lakh crore in total) that added liquidity ("QE-lite") [2][3]. Special OMOs had a matching sale leg, so they added no net liquidity.

Prelims Hooks

• Operation Twist = buy long-term securities + sell short-term securities at the same time → long yields fall and net liquidity is unchanged.
• Fed used Operation Twist in 1961 and 2011-12. The RBI's version is the special OMO (December 2019 - 2020).
• Trap: Operation Twist changes the composition (mix) of the central bank's holdings, not the size of its balance sheet. A statement saying "it increases money supply" is wrong.
• Effect on the yield curve: it becomes flatter. The long end falls and the short end stays flat or rises.
• RBI special OMO (auction on 3 September 2020): ₹20,000 crore in two ₹10,000 crore tranches. It bought 7.72% GS 2025, 6.79% GS 2027 and 5.79% GS 2030, and sold 182-day T-Bills [1].
• Which tool adds liquidity? QE and G-SAP add liquidity. Operation Twist does not.

Mains Points

• Fixing transmission without inflation risk: when repo rate cuts do not reach long-term borrowers, Operation Twist lowers long-term yields directly. Because net liquidity stays unchanged, it avoids the inflation and asset-bubble risks of full QE. This makes it well suited to an inflation-targeting central bank like the RBI (GS-III: monetary policy).
• India's calibrated, "bounded" approach: special OMOs (2019-20), G-SAP (2021) and TLTROs (2020) lowered long-term yields during COVID-19. They avoided open-ended QE and direct deficit monetisation, which protected RBI's credibility and the inflation-targeting framework. Limit: Operation Twist can only work while the central bank has enough short-term securities to sell, so it cannot be scaled up without end.
• Link to government borrowing: lower long-term G-sec yields reduce the government's interest cost on large borrowing programmes. This raises the question of where support for bond markets ends and fiscal support begins (GS-III: fiscal policy; GS-II: independence of statutory bodies).

Related concepts

• Unconventional monetary policy
• Quantitative easing
• Quantitative tightening
• Negative interest rate policy
• Yield curve control
• Helicopter money
• Taper tantrum

Read more

• Unconventional monetary policy: the global toolkit and India's use of it