Setting monetary policy becomes more challenging for RBI if segments like government debt or forex are even partly regulated by other authorities
Three issues have been flagged in the Budget, probably indicating the prevailing thought process—which is to reshuffle regulatory oversight within the financial markets for certain segments with the possibility of creating new structures. These issues relate to handling of public debt, trading of the same in the secondary market, and oversight of forex inflows through equity.
In India, there are multiple regulators in the financial sector where players come under different regulators or quasi-regulators such as RBI, Sebi, IRDA, PFRDA, Nabard, FMC (till recently), and Sidbi. This is because every market player has to contend with regulation in other markets as they operate across segments. A bank, for instance, is under RBI, but when it gets into investment banking, it has to look at Sebi’s guidelines, and has to adhere to IRDA’s rules while selling insurance products. Pension funds come under PFRDA, but when investing in, say, the debt market, they have to follow Sebi guidelines. Therefore, prima facie, having multiple agencies is not really odd. By changing jurisdiction to other regulator or entities, the function is still carried out by the government-appointed entities and should not really matter.
But the issues flagged in the Budget are significant as RBI has certain functions to perform within the realm of monetary policy, which would become more challenging if segments such as government debt or forex are under other regulators either partly or fully. Having a PDMA (Public Debt Management Agency) could mean ending up with the same department being shifted elsewhere, but doing the same function of issuances and management of government borrowing. However, when RBI has to conduct monetary policy, then it has to perforce have regulatory power over all aspects of government paper.
If they were held with the PDMA, then RBI has to necessarily become a player in the market to gain access to gilts. This is because it needs government paper for conducting its repo/reverse repo auctions under LAF as well as open market operations. If it is not in charge then it has to conduct its own operations in the market to pick up G-Secs and then become a player in the market, which can tilt the scales given the volumes required. An argument often put forward is that there is conflict of interest when RBI is in charge of public debt. This is not true as RBI has little interest in how the prices of gilts move. In fact, the same concern would be more in case of the PDMA, which would be a government outfit, and which can have probably greater interest in keeping the rates under check.
Trading in G-Secs currently comes under the central bank with the CCIL providing the platform. The logic of shifting all such trading to Sebi is sound as securities, forex futures and commodity futures are all under this umbrella. The advantage is that by getting in G-Secs, an individual can also trade in gilts. A question to be asked is that on such a platform, can a broker who is not a financial institution be allowed to trade? This would have been ideal but for the fact that the G-Sec market is critical from the point of view of monetary policy as the market is largely influenced by the RBI action and the efficacy of transmission also gets reflected from the trading that takes place. Getting in more players can lead to unjustified volatility that comes in the way of understanding the true dynamics of the market.
The change in the policy rate, i.e. the repo rate, is seen in the G-Sec market to begin with before banks decide to take action on deposit and lending rates. RBI, by having oversight on the market for gilts as well as trading, is able to realign structures which include reissue of paper, yield curve determination, correcting yield structures, liquidity, etc, as its own OMOs have a bearing on the price movement. Therefore, the strong link with monetary policy justifies having the same entity regulating monetary policy and trading in gilts.
In the new perceived scenario, RBI would be conducting monetary policy with the PDMA overseeing the issuance of government debt. The movement of yields would be determined in the secondary market where the regulator will be Sebi, which will be more concerned with fair play, and the priority would not be related to the effectiveness of monetary policy action of RBI. The issue becomes ticklish with the recent agreement between the ministry of finance and RBI to have in place a monetary policy committee responsible for inflation control. Inflation targeting becomes perplexing as RBI will have no say over conduct of public debt and trading in gilts which affects interest rates and hence bank business parameters in a situation where the government already runs a deficit based on its need, which is not in the purview of monetary policy.
The forex market is quite unique in the sense that RBI has to control the movements in currency, ensure that the reserves are stable and regulate the forwards market, while Sebi oversees the futures market and no one controls the NDF market which influences the spot rates. Now, if RBI is the agency to be in control of the forex rate and reserves, then it has to necessarily have oversight of these inflows under FEMA. The issue stops not just at the exchange rate but also the implications on monetary policy. FIIs inflows can create monetary issues that have to be addressed by RBI. Thus, the central bank has to have a say here.
The existing structure of RBI oversight has been created with a purpose of ensuring stability and better transmission of monetary policy. Having different regulators should not ideally create a difference of opinion but as each one focuses on development of its own terrain, there could be speed breakers for the central bank. And the latest twist in tale that makes RBI responsible for the inflation rate adds a new dimension. Ideally, the new monetary policy committee and its functioning should be administered first before evaluating the efficacy of the same when these props—PDMA, secondary market operations and forex equity flows—are removed. This may be a pragmatic approach.
The author is chief economist, CARE Ratings. Views are personal