by Radhika Pandey and Bhargavi Zaveri
The CAG report on public debt management tabled in Parliament on 26th July, 2016, has made several adverse observations on the current state of public debt management in India.
- It found the legal framework governing public debt lacking in several respects. The present legal framework on public debt does not define basic concepts such as ‘public debt’, does not indicate the objectives of public debt or the purposes of borrowing. It does not require the formulation of a strategy for the management of public debt.
- Over the past two decades, all expert committees have recommended setting up a public debt management agency (PDMA) for performing the debt management function. However, except for a middle office (which also does not perform the functions assigned to it), no progress has been made on this front.
- There is no entity that performs functions relating to the external debt of the Central Government such as analyzing and monitoring risks and assessing the performance of debt managers against strategic targets or benchmarks.
Apart from the desire of the government to make more-than-incremental reforms, there are two other reasons why it is an opportune time to resume the long-delayed work of reforming the framework for public debt management in India. One, RBI has formally adopted inflation-targeting as the objective of its monetary policy, which heightens the conflict of interest between its role as the investment banker for the Government and the inflation target. All mature market economies separate debt management from monetary policy. As an example, the IMF guidelines on public debt management have emphasized that there should be separation of debt management policy and monetary policy objectives and accountability.
Two, RBI has formulated a road map for progressive reduction in SLR (the funds that banks are forced to keep invested in government securities). The SLR is proposed to be brought down by 0.25% every quarter till March 31, 2017. Reducing this `financial repression’ is a good thing. But simultaneously, this makes life more difficult for public debt management. We need new institutional arrangements alongside breaking with the old, distortionary ways.
Greater diversification of the investor base of government securities, in the quest for voluntary buyers, is required. The cozy arrangements of today for debt management and the bond market will not work in the emerging world.
It is poor policy analysis to proceed with inflation targeting, but not give the central bank the tool of a liquid bond market through which the inflation target will be achieved. It is poor policy analysis to reduce financial repression, but not plan for the complexities of public debt management in that new environment.
The Faulty Pubic Debt Framework
- The elephant in the room is the lack of an independent public debt management agency (PDMA). This has formed the subject of much discourse in academic and policy circles. From the mid 1990s onwards, all expert committees in India have advocated setting up the PDMA. A recent IMF Working Paper on designing legal frameworks for public debt management has advocated “centralization of all debt functions in one single unit to reduce fragmentation and enhance coordination in debt management”.
- When a principal engages an agent to undertake a specific task, the contract between the principal and agent must be tight enough to build in accountability, performance measures, and at the same time allow the agent to perform its task without interference in transactions. While there is a lot of talk of “independence” for government agencies in India, this needs to shift to a mix of accountability on performance and autonomy on transactions. The current legal framework dealing with public debt management in India is scattered across several laws such as the RBI Act (which obligates the Central Government to entrust the debt management function to the central bank), the Government Securities Act, 2006 (which deals with manner in which RBI will hold government securities, terms and conditions of government securities, etc.) and the Public Debt Act, 1944 (which continues to apply to Jammu and Kashmir). None of these laws codify performance measures or build accountability mechanisms for the agent to perform its task.
- As the RBI only deals with marketable debt, a single repository containing all the data which is required for an overall picture of the outstanding liabilities, including contingent liabilities, of the Central Government is not available. As this information is absent, it is not possible to formulate or implement a strategy for public debt management. What we do in public debt management is all transactions and no strategy.
- Market infrastructure for the government bond market (the exchange and clearing house) is owned and managed by RBI. The weaknesses in how this management is done has been an important source of failure in bond market development. Decisions about the appropriate market infrastructure for government bonds are best placed at the PDMA, which would be accountable for delivering low cost financing for the government, and would thus have the incentive to think about how to organize these markets.
Law and Order in Debt Management
The Financial Sector Legislative Reforms Commission (FSLRC) which recommended the establishment of a PDMA also drafted the blueprint of a law, the Indian Financial Code, that will govern its functioning. The key elements of the Indian Financial Code governing the functioning of PDMA are summarized below:
- It defines ‘public debt’ to mean internal and external borrowings of the Central Government. This would ensure that there is one single entity that has an overall picture of the outstanding liabilities of the Central Government, both internal and external.
- It codifies the objectives of the PDMA, namely, to minimize the cost of raising and servicing public debt over the long term and to keep the public debt within an acceptable level of risk at all times. For the first time, the manager of the public debt has clearly defined objectives which also translate into measures by which its performance may be judged.
- It entrusts the management of existing and contingent liabilities on the PDMA. This ties in with the requirement of having a single manager who will manage all outstanding liabilities of the Central Government. The concrete output will be a single repository of liability-related information.
- It codifies the relationship between the principal (Central Government) and the agent (PDMA, as the debt manager) in precise terms. For example, it obligates the PDMA to formulate an annual debt plan and a medium term (three year) debt plan, get the same approved from the Central Government and then implement it. The law also codifies detailed requirements for publication of the debt plan as well as a calendar for issuance of government securities.
- It obligates the PDMA to foster a liquid and efficient market for government securities. It empowers the PDMA to advise the Central Government on market design and allow equal access to this market, as an integral part of this market design. Contrast this with the existing framework which is lacking in details on the market structure for government debt.
- The entire machinery of governance, such as annual reports of defined standards, performance evaluation, external audits, etc. have been made applicable to the PDMA.
A short while ago, this work was done, but then it was rolled back. The Finance Bill, 2015 tabled in the Parliament proposed the establishment of a PDMA and its functioning broadly on lines described above. Subsequently, the reform was rolled back with a promise that the “…Government in consultation with RBI, will prepare a detailed road-map separating the debt management functions and market infrastructure from the RBI, and having a unified financial market.“
It is a big missing link in the Indian reforms.
Radhika Pandey and Bhargavi Zaveri are researchers at the National Institute for Public Finance and Policy.