The separation of debt from monetary management in India has once again been postponed. First, on the basics, the main objective of debt management is to minimise the cost of borrowings over the medium to long run, consistent with a prudent degree of risk. Historically, there was a consensus among practitioners until 2008 to treat debt management as a separate policy instrument from monetary policy. A number of countries with liberalised financial markets and high levels of government debt sought to adopt professional debt management techniques to save cost and to provide policy signals to the market. The trend started with New Zealand, a country from where inflation targeting originated, in the 1980s, with the government recognising the need for proper policy assignment and an accountability framework for debt management to meet the fiscal targets of the government. Also, the debt crises of 1982 and the East Asian financial crisis of 1997 led many more countries, including the UK, to separate debt from monetary management.
In normal economic circumstances, the central bank operates at the short-end of the market and debt management at the long-end to minimise cost of raising resources, but in times of crisis, the operations can become blurred. Therefore, after the global crisis, the issue of separation of monetary policy from debt management re-emerged, as debt-to-GDP ratios increased significantly and debt management encountered difficulties.
Reasons for separation
Several reasons emerge that justify an independent debt management office—to preserve the integrity and independence of the central bank, to shield debt management from political interference, to ensure transparency and accountability, and to improve debt management by entrusting it to portfolio managers with expertise in modern risk management techniques. The separation of debt and monetary management positively affects expectations as it explicitly indicates to the market that monetary policy is independent of debt management. In case the two are not separated, then debt management eventually becomes subservient to the monetary policy as monetary authorities generally attempt to use debt instruments to enhance credibility of the central bank.
The classic conflict between monetary policy and debt management relates to the fixation of interest rates. The interest rates on government securities are crucial in determining the yield curve and prices of financial assets in the economy. In case the central bank conducts debt management, conflicting signals may emerge. Questions arise such as whether liquidity should be tightened based on monetary conditions prevailing in the economy or relaxed to ensure success of market borrowing programme of the government?
In case of developing countries, where financial markets are generally underdeveloped, there is yet another concern and that is the limited financing options of the government and uncertain cash requirements that constrain independence of the central bank. Taylor (1998) argued that the accord between the Federal Reserve and the Treasury in 1951 in the US, which emancipated the Fed from assisting the Treasury in borrowings at low rates of interest, helped the Fed to focus on monetary policy.
Need for coordination
In each country, the economic situation, including the state of domestic financial markets and the degree of central bank independence, would play an important role in determining the range of activities to be handled by the debt manager and the level of coordination that is necessary with monetary authority. Monetary policy and debt management clearly have to be complementary to each other but debt management should not be considered a tool of monetary policy nor should monetary policy be considered the objective of debt management (Bank of England, 1995). In the case of developing countries with underdeveloped financial markets, coordination between fiscal, monetary and debt management functions is considered even more crucial.
Debt management in India
In India, debt management function is divided between central and state governments, and RBI. The key role in management of internal debt is played by RBI which could conflict with its pursuit of the objectives of monetary policy. RBI has to balance needs of markets (manage liquidity), government requirements (short- and long-term fiscal requirements), balance sheet of banks (asset prices and interest rate movements) and general price level (growth of money supply).
The separation of debt management would provide focus to the task of asset-liability management of government liabilities, undertake risk analysis and also help the policy-makers to prioritise public expenditure through increased awareness of interest costs. The separation would also imply that the borrowing programme would have to be completed without any support of the regulatory or supervisory authority, ensuring market-determined yield curve and consequent widening of the investor base.
A focused approach on debt management could also facilitate especially tailored schemes for different segments of the market. However, before undertaking the separation of monetary and debt management, the government may have to consider revising the statutory liquidity ratio under which commercial banks have to invest at least 23% of their deposits in government securities. The joint family approach for debt and monetary management does not augur well for transparency in both debt and monetary management especially when the central bank is balancing different objectives. Finally, the roadmap for separation needs to follow cautious sequencing of events, even after numerous consultations and negotiations.
The author is RBI Chair Professor of Economics at IIM Bangalore.
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