IT WILL LEAD TO MORE TRANSPARENCY
The merits of setting up an independent Public Debt Management Agency (PDMA) has been adequately debated for more than two decades now and there is very little scope left for any new deliberations on this. Many developed countries have shifted to an autonomous PDMA over the years. And the fact that none of these countries have revisited their decision or have asked central banks to reassume the responsibilities of debt management further reinforces the sustainable advantages of such a transition.
In the Indian context, however, the reason for such prolonged debate is that the Reserve Bank of India (RBI) has done a phenomenal job of public debt management over the years. The RBI has successfully handled its dual role of debt management and monetary policymaking. There has not been a single instance when the market regulation role of the RBI has conflicted with its monetary operations in the money and government securities market. That said, moving towards best practices should be the endeavour of the government, and at some point, we should aim to emulate the independent model, which has proved to be successful across several developed countries.
At present, the RBI is responsible for all internal debt management functions, while external debt falls under the purview of the Department of Economic Affairs under the Ministry of Finance (MoF). Bringing together all government borrowings under one roof is propagated as a key reason for the creation of an independent PDMA. A separate agency, which assigns specific responsibilities and is accountable on its own, will lead to a more transparent and efficient system. This is seen as a necessary step towards deepening of the bond market. Today, the bond market has limited participants, where the RBI, along with the commercial banks, plays a major role in the funding of the government borrowing programme. Once the debt management function is separate from the RBI, the government will hopefully be able to tap funds from a larger pool of resources.
To achieve this objective, the government announced its intentions to set up an independent PDMA as part of its budget proposals. More recently, the government has withdrawn the PDMA-related clauses from the Finance Bill and has deferred its plans in order to implement this in a phased manner. This could be a positive as the government now plans to work in collaboration with the RBI, which has rich experience in the successful management of public debt. This approach is expected to lead to an organised execution based on a well thought-out roadmap.
There are fears of market volatility caused by the shifting of responsibility to a new agency. However, these are temporary concerns that can be alleviated by ensuring that the MoF and the RBI work closely to keep the developments in check. Currently, some RBI officials are acting as coordinators between the government and the central bank in matters related to public debt. While initial challenges are to be expected in this transition, a smoother functioning will follow once credibility is established.
From a broader perspective, it is essential to enable the central bank to direct its attention to the single objective of inflation targeting, as mentioned in the MoU signed between the RBI and government earlier this year. The credibility of such MoU will remain diluted if the RBI is burdened with the role of debt management. The proposed framework will provide clarity to the RBI about its role in inflation management without the conflict of a mandate for achieving lower borrowing cost for the government. Simplicity of objectives is essential for success in the present volatile, uncertain, complex and ambiguous (VUCA) world. The governments and central banks are no exceptions to this.
PIECEMEAL REFORM SIMPLY WON'T DO
Sometimes piecemeal reform simply won't do. The move to separate the Public Debt Management Agency (PDMA) out of the Reserve Bank of India (RBI) is a case in point. The separation of the PDMA is actually a part of a reform that involves at least four other elements. If none of these four other steps are undertaken simultaneously, then taking the PDMA out of the RBI is a worse outcome than status quo. The four steps that must accompany the PDMA separation are:
>> Elimination of the SLR (statutory liquidity ratio) requirement for banks.
>> Substantial reduction (if not elimination) of public sector ownership of banks.
>> Making market valuation of government bonds compulsory (with no exemption).
>> Commitment to opening up the capital account, for eventual co-mingling of rupee and dollar sovereign debt.
These four conditions (and doubtless there are other prerequisites as well) already hint at why merely separating the PDMA without any concomitant reform is unwise. The raison d'etre of the PDMA is to remove the conflict of interest within the RBI, that is both banker and debt manager to the government, which also fixes interest rates. So an inflationary deficit financing might call for floating more bonds, but will also call for higher interest rates. What will the RBI choose? The RBI has actually managed this so-called conflict quite splendidly for decades. If the PDMA moves to Delhi, then it is more likely that the government of the day may be tempted to push its debt onto bank balance sheets.
Governments have shorter and more political time horizons, so the danger of influence of conflict of interest is more acute. That's why it is essential that banks be freed from the SLR obligation to buy government bonds. This can happen only if the RBI brings down the SLR to zero. That must be a concomitant to moving the PDMA out of the RBI. It is also essential that public sector ownership is reduced, so that Delhi does not have undue influence in forcing banks to hold government debt.
The third issue is of assigning proper market value to government bonds in bank balance sheets. Currently, more than half the government debt is not marked to market. This exemption allows the cost of debt to be insulated from the pressure of the yield curve. Indeed, for past seven years, the average cost of debt for the government has been about 200 basis points below the inflation rate. This low cost was achieved thanks to financial repression (through SLR) and not valuing bonds at with true market prices. Otherwise the banks would have booked huge losses, leading to a regulatory headache.
When under fully independent PDMA with zero SLR regime and market valued bonds, if the cost of debt starts rising, then the government can tap overseas dollar investors, i.e., sell dollar denominated sovereign bonds. But this would call for a much more open capital account. We are certainly not ready for that. Beyond the four issues outlined above, is also the issue of how to deal with state government debt. The PDMA will only manage sovereign debt. Currently, the states' debt rides piggyback on the infrastructure created by the RBI. We will need to address this aspect as well, before the PDMA is separated. In the current scenario of greater federalism, this is an important aspect.
It is not as if we have made zero progress in reforming the government debt and bond reform. The RBI does not automatically monetise debt as it used to. It does not participate in primary auctions. The debt market is fairly liquid, and we have a reliable risk free rate used as a benchmark. The best practice in the world offers mixed evidence in favour of an independent debt office, outside the central bank. What ain't broken need not be fixed hastily. Hence a separate PDMA can wait till the other pieces of the jigsaw are in place.