Unburdening RBI

Financial Express, 9 March 2012

The government has announced its commitment to table the Public Debt Management Agency of India Bill in Parliament in budget session 2011-12. This will pave the way for an independent Debt Management Office (DMO).

At present, the Reserve Bank of India is the debt manager for domestic debt of the central and state goverments. All advanced countries have moved away from having the central bank manage their public debt. In some cased a department in the treasury manages the debt, while others have independent DMOs. No modern economy mandates the banking regulator to manage the borrowing programme of the government.

An independent DMO allows the government to allocate the function of managing its debt to an agency whose mandate is to focus entirely on how to reduce the cost of borrowing from the government in the long run. It takes it away from the monetary authority who may have conflicting mandates that take its attention away from this main task as it raises interest rates to keep inflation low. A DMO within a banking regulator can create a perverse incentive for the regulator never to allow the economy to move away from financial repression as it can achieve both objectives of low cost funding for governnment and reduction in banking sector risk through a requirement like a high Statutory Liquidity Ratio (SLR) as in India.

The discussion on an independent DMO in India has been in progress since the RBI proposed it in RBI Annual Report, 2000-01. It said: "The separation of the functions of debt management and monetary management is regarded as a desirable medium-term objective... The separation of the two functions is expected to have significant effects on the functioning of the government securities market... The Reserve Bank has proposed amendments to the Reserve Bank of India Act, 1934 which would take away the mandatory nature of management of public debt by the Reserve Bank and vest the discretion with the Central Government to undertake the management of the public debt either by itself or to assign it to some other independent body, if it so desires."

This recommendation received support in following expert committee reports such as the Raghuram Rajan and the Percy Mistry reports. The Ministry of Finance set up an Internal Working Group on Debt Management headed by Jahangir Aziz. The Union Budget 2007 announced: "World over, debt management is distinct from monetary management. The establishment of a Debt Management Office (DMO) in the Government has been advocated for quite some time. The fiscal consolidation achieved so far has encouraged us to take the first step. Accordingly, I propose to set up an autonomous DMO and, in the first phase, a Middle Office will be set up to facilitate the transition to a full-fledged DMO."

The MoF Internal Working Group submitted its report in 2008. After this the story took an unexpected turn. The RBI changed its views about an independent DMO. RBI Governor D Subbarao argued:" Management of public debt, therefore, has necessarily to be seen as part of broader macroeconomic management framework involving various tradeoffs". "...only the central bank can make "judgements which an independent debt agency, driven by narrow objectives, will not be able to do."

Actually, instead of being an argument in favour of keeping the DMO function within the central bank, as Governor Subbarao says, the above is a strong argument for giving the job of managing the central government's debt to an independent agency with a narrow objective. Interntionally this has been one of the main pillars of the logic for moving the DMO out of central banks. Central Banks as monetary authorities have the prime responsibility of price stability. If price stability requires raising interest rates then the central bank will do so. This will push up the cost of borrowing for the government. A central bank that is mandated with both these objectives will find it hard to meet them.

Second, the Governor argues that now is not the right time to separate the DMO due to high fiscal deficits. Again, the logic for separation is strongest when the deficit is large. Gains from professionalism are much higher when fiscal deficits are higher. If the country ran a fiscal surplus, it will perhaps not need a DMO. If it ran a small deficit, then gains from interest payment reduction, and thus a DMO will be small.

Another argument made in favour of keeping the DMO within RBI is supposed to be the changing views of some scholars on the issue after the global financial crisis. In a post crisis paper Charles Goodhart says: "When markets get difficult, and government bond markets are likely to do so, the need is to combine an overall fiscal strategy with high-calibre market tactics. The latter is what Central Banks have as their metier. During the coming epoch of Central Banking, they should be encouraged to revert to their role of managing the National Debt." This argument has not seen much support among central bankers. Stanley Fischer, Governor of Bank of Israel says: "The paper suggests that the central bank should manage the national debt. The Bank of England used to do that, but it is not at all clear that the suggestion is a good one. The national debt is issued by the treasury, and can - and probably should - be managed either by the treasury, in consultation with the central bank, or by a separate debt office that should also manage the debt in consultation with the central bank." Also, it is of significance no country has moved the debt management function back to its central bank following the crisis.

In the light of the above, the decision of the central government to continue with is plan to set up an independent DMO is the right one. Introduction of the bill in parliament will pave the path to do so.

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