Fresh look at debt management

One significant announcement by the Finance Minister in the Budget was the proposal to introduce the Public Debt Management Agency of India Bill in 2011-12, paving the way for the constitution of an independent debt management office (DMO).

Two aspects need careful attention in preparing the new legislation. First, the scope and functions of the new agency and, second, the nature of the organisational structure which, in a way, will depend upon the first.

Integration of functions

There are at least four major issues that need to be addressed regarding the scope of DMO's functions. One, whether the DMO should manage only Central Government debt or State loans also. From the macro perspective, public debt would include the debt of both governments.

The Thirteenth Finance Commission has laid down a roadmap for fiscal consolidation which covers both governments and one important target to be monitored is the individual and combined debt-to-GDP ratio of both governments.

Hopefully, the proposed amendment to the Fiscal Responsibility and Budget Management legislations would incorporate, inter alia, this new parameter, apart from the golden rule of keeping the current deficit at zero level. The DMO should, therefore, encompass within its fold State government debt also.

Two, whether the DMO should focus upon cash and investment management functions too. Cash management and debt management are intricately related. Recent experience has brought to light that the Central government could not cope with the huge accumulation of cash surpluses on account of windfall 3G revenues, creating distorted liquidity and interest rate conditions as the government did not create possible avenues for investing such surpluses, as practised in other countries.

The cash balance position of the Central Government is also closely linked to the State Governments' balances since the latter temporarily places surpluses with the Central Government. The cash balance position and dependence of both governments on the RBI for ways and means advances or overdrafts is influenced by the complexity of fiscal transfers and other inter-governmental transactions. For these reasons, the DMO should integrate within its scope the cash and investment management functions of the governments at both Centre and State. The third issue is whether the DMO should manage the external debt. State governments cannot directly borrow from abroad and have to go through the Centre as the sovereign risk is essentially borne by the latter. While the Centre is yet to issue a sovereign paper abroad, at some stage, it has to test that source — and that time is not too far, looking at the way markets are getting integrated. Considering all these, and the risk associated with debt, it cannot be viewed in isolation; thus, both internal and external debt should fall under the purview of the DMO.

Last, but not least is the issue of whether only marketable debt should engage the attention of DMO or the entire contractual liabilities of governments, including small savings and provident fund receipts.

The Twelfth and Thirteenth Finance Commissions have kept these liabilities outside the purview of debt to GDP targets, on the ground that these liabilities are part of public accounts and not a part of consolidated funds. But they influence the cost of raising debt and provide indirect support to governments. Therefore, this question needs to be addressed before a view is taken on the DMO's scope of activities.

IndependenT Policy

One basic reason for the creation of a DMO is to separate debt management from monetary management so that any conflict of interest between the two is avoided. This is remarkably true since interest rate setting, as also use of other instruments such as cash reserve ratio and open market operations (OMO) by the RBI, can be clouded by debt management objectives.

Dr Subir Gokarn had to clarify to the public recently that OMO is a monetary operation and not a part of debt management. While avoiding such conflicts, it also needs to be recognised that the two functions are indeed complementary. Therefore, the broad approach should be independent functioning of debt management consistent with fiscal and monetary policy stance and objectives. Second, the Reserve Bank has been managing only the internal market borrowings of both the governments and neither the external debt nor the other internal liabilities of governments. As interest rate conditions are influenced by these, the RBI's close relationship and coordination with DMO should not be overlooked.

Third, the RBI will still have regulatory control over money and government securities markets and is also expected to continue with other agency functions such as maintaining the depository, managing the settlement system and conduct of auctions on behalf of the DMO.

Desirable structure

Institutionally, it is very important that the relationship between the Central and State Governments, and of both with the RBI, need to be considered in designing the organisational structure of the DMO.

The DMO needs to function independently, maintaining an arms-length association with all these entities. Considering these two aspects, it would be ideal to set up a statutory corporation with equal participation from the three, with independent goals and objectives.

(The author is Director, EPW Research Foundation. The views are personal. >blfeedback@thehindu.co.in )

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