Pangs of Separation: Debt Mgmt & Monetary Policy ET dt. 28-!-"!

Over 15 years ago, an RBI working group first suggested separation of debt management from
monetary policy functions of the central bank. hough many countries have done this in the
midst of crisis, it may be a challenge for the Indian govt which is still struggling to address fiscal
dominance, says !ha"i #ikraman
$ell over 15 years ago,a working group of the Reserve Bank of India first suggested the
separation of its debt management and monetary policy functions of the central bank. In keeping
with global practices of the time, the group made out a case for separating the role of a bank in
managing borrowings for the central and state governments, leaving the RBI to focus mainly on
setting interest rates and price stability. %lthough the government first announced its intention to
form a new debt management office in &''(,there has been little progress. he move came
appropriately at a time when the process of fiscal consolidation was well underway. )conomic
growth was buoyant then and public deficit and debt indicators, too, were under control. But the
Indian central bank did not appear to be fully convinced and reckoned that the timing wasn*t
right. !ince then, in the wake of the global financial crisis, there has been some rethink about the
perceived benefits of a separation of public debt management from monetary policy, especially
in the conte+t of the poor state of national balance sheets. India has not been an e+ception to this.
Is there a case for back,pedalling on this proposal !everal committees, including the ones headed
by -ehangir %.i. who was the principal adviser to the government in the ministry of finance
Raghuram Ra"an and /ercy 0istry, had listed the operational efficiencies, which could be gained
by having an independent debt management office. hese include eliminating a conflict of
interest involving a central bank setting short term interest rates and selling bonds for the
government, reducing the cost of debt, facilitating debt consolidation and increasing
transparency. 1ould these benefits be overstated he primary conflict, which is generally
associated with a central bank managing sovereign debt relates to its inherent responsibility as
the monetary authority, and its obligations as a debt manager. It has been argued by all those
pitching for a bifurcation of functions that the central bank will be biased towards a low interest
regime to cut the costs of sovereign debt, at the risk of compromising its anti,inflation stance.
he Indian central bank has countered this by saying that in countries such as India, given the
large si.e of the government borrowing programme, the sovereign debt management is much
more than merely an e+ercise in resource,raising, as it could impact interest rates which, in turn,
could have wider public policy implications. Other arguments which have been put forward by
those backing the RBI are that the si.e and dynamics of government borrowing programmes
have a much wider influence on interest rate movements, systemic li2uidity and even loan
growth through the crowding out of private sector loan demand. Besides, management of public
debt, therefore, has necessarily to be seen as part of broader macroeconomic management
framework involving various trade,offs. %ccording to them, once this is recogni.ed, the
centrality of central banks in this regard becomes 2uite evident and that only central banks have
the re2uisite market pulse and instruments to aid in making conte+tual "udgements, which an
independent debt agency, driven by narrow ob"ectives, will not be able to do. 3urther, they argue
that it is not that these conflicts will be eliminated "ust by shifting debt management out of the
central bank. In fact, resolving those conflicts could become much more complicated leading to
inferior outcomes. his is because even after the separation, the central bank would continue to
be e+pected to manage the market volatility and market e+pectations arising out of government
borrowing. he other concern which has been flagged off is that if debt management is moved
away from the RBI to 40O, which could function as an e+tended arm of the ministry of finance,
the possibility of conflict of interest is greater as the government is the owner of the ma"ority of
banks in India. his conflict of interest is more potent in the backdrop of banking sector
continuing to be the dominant player for government market borrowing, with banks holding over
5'5 of outstanding government securities. his is something the government has been mindful
of. )ven if such conflicts do e+ist, the benefits of consolidation, freeing of monetary policy and
dovetailing with easing financial repression are obtained by reforms to debt management, the
-ehangir %.i. committee had said. It went on to say that it could be possible to distance the
functioning of the debt management office from the government at the operational level. %ll that
does not appear to have assuaged several other concerns of the RBI. In a scenario marked by
e+cess capital flows, which calls for intervention in the fore+ markets by the RBI and the
conse2uent sterilisation through issuance of government bonds by the RBI, the coordination of
debt management with monetary operations cannot be snapped, it says, making the case for
separation weaker. It is also worried about the potential conflict with li2uidity management by
the RBI reflected in the fact that when there is surplus li2uidity, the auctioning of governments
cash balances by an independent debt management office will add to the surplus volume in the
system which, in turn, will have to be mopped up by the central bank for efficient monetary
policy transmission. he global financial and sovereign debt crisis has prompted a review of
some of these arrangements. Iceland has transferred debt management functions back to its
1entral Bank, while a few other countries have put it on hold. 1harles 6oodhart of the 7ondon
!chool of )conomics and a former member of the 0onetary /olicy 1ommittee of the Bank of
)ngland wrote in the 3inancial !tability Review of the Ban2ue de 3rance last year that when the
public sector of a country becomes so indebted and its fiscal sustainability is potentially at risk,
then monetary policy has to be perforce closely integrated with debt management and fiscal
policy. %s fiscal policies have recently been compromised and debt ratios have become much
enlarged, that separation principle is becoming sub"ect to increasing stress. 6oodhart has been
2uoted as saying that debt management is again becoming a critical element in the overall
conduct of policy, as events in 6reece have evidenced and that debt management can no longer
be viewed as a routine function, which can be delegated to a separate, independent body.
-ehangir %.i., now 1hief )conomist, %sia, of -/0organ says that there is nothing in
international e+perience that suggests that there is a well,defined set of circumstances when it is
optimal timing to set up a 40O. %ccording to him many countries have actually done this in the
midst of crisis and as an integral element of crisis management. Only future events will tell us
whether the potential conflict of interest has been eliminated or not. But the first step is setting
up an independent 40O, 8he says. 3or a government struggling to address the issue of fiscal
dominance and heading into polls in "ust a year from now, it certainly is going to be a huge
challenge.sha"i.vikraman9timesgroup.com