In recent years, the money borrowing programme of the Union government has been formidable. It is usual for fiscal deficit to cross the 5% mark when accounted properly. Given the stage of evolution of financial markets in the country, the task has been accomplished quite smoothly. And this has been, in no small measure, due to careful management by the Reserve Bank of India (RBI): the central bank has ensured that bond and equity markets don’t get roiled due to the massive amounts being raked in by the Behemoth in New Delhi.
All this may change, for the worse, if the government’s plans to set up an “independent” debt management office (DMO) come to fruition. The plan to establish DMO is old. It was announced first in the 2007-08 budget. It has been reiterated this year. Since then, RBI has voiced its concern at this hiving off of a vital function. This has been met by a chorus of arguments, mostly specious, from the government’s side. The latest being by economic affairs secretary R. Gopalan in a recent interview.
These can be summed up easily: there is a conflict of interest between the debt and inflation management functions of RBI. As the government’s debt manager, RBI would like to issue bonds at a low interest rate to ensure cheap money for it. As an inflation manager in an economy with built-in inflationary pressures, it has to set higher interest rates to cool prices. Creating an independent DMO will, it is said, end this dilemma.
This is, at best, an excuse. In reality, the central bank’s independence to set policy rates is constrained by a host of factors, among which government “persuasion” is certainly one, if unsaid, factor. So this contradiction is quite muted in practice.
If anything, a DMO under the finance ministry is bound to create a far more serious conflict of interest. Most government debt is purchased by banks and big insurance companies. The government is the owner of these entities. Once it gets the power to set the interest rate on the debt it issues, the temptation to borrow large sums at arbitrarily low rates will be too strong to resist. It will, so to speak, become a market maker for its debt, a scary prospect for financial markets. Given the history of fiscal recklessness of governments in India, this will be a bad move from a market perspective.
If the government wants to set a DMO, it should first divest its majority stake in banks so as to make these truly independent. Unless that is done, the government will end up creating a far bigger hazard.
An independent DMO: independent in name only? Tell us at email@example.com