Reform RBI Workload to Boost Debt Market

It has long been evident that India needs a vibrant market for corporate debt, one that goes beyond thinly traded papers which are mostly top rated. We need the pricing of risk to improve, while the risk-return options on offer expand to fund many more businesses and satisfy more investors. Indeed, we must deepen our debt market as a whole if the basic price of money in the economy is to balance savings and investments with the efficiency that our pursuit of prosperity demands. In her 2021 budget speech, Finance Minister Nirmala Sitharaman spoke of an “institutional framework” to support demand for “quality debt securities”. To this end, the government has reportedly held talks with the Securities and Exchange Board of India, and a plan is expected to take shape within a month for a state-sponsored entity to be created and capitalized to buy good quality debt in periods of stress, such as the recent shadow lender crisis, and also minimize cases of illiquid paper in general. However, for this project to act as a debt market booster, we also need a government securities yield curve (G-Secs) across loan maturities that can reflect credit conditions reliable enough to serve as a basis for other bond prices.

To enable the above, we would have to dust off a proposal that has been sitting on our political shelf for a quarter of a century. The role of the Reserve Bank of India (RBI) as debt manager of the Center should be separated, so that it does not conflict with its mandate to cap inflation. In 1997, this reform was suggested by a panel set up by RBI under SS Tarapore to consider how we could make the rupee fully convertible for capital flows. Given Asian currency jitters that year, full convertibility was delayed, but the panel’s call for giving up a tricky secondary function of India’s central bank was an idea whose time had come. It has twice been part of our Union budget proposals. In 2007, P. Chidambaram, as Minister of Finance, proposed a separate agency to manage public debt. Eight years later, Arun Jaitley revived the proposal, but consensus proved elusive and it was again shelved. Today, it can no longer be postponed. A potential fork in our political path ahead gives it urgency.

The increase in budget expenditures driven by the Centre’s covid response has already brought our public debt burden to a level that must be reduced sharply over the next few years if interest expenditures are to ease their outsized claims on our treasury. Sustained support in 2022-23 for an economic recovery will lead to further debt, but this time with the growing risk of a spike in inflation. An easy way out would be to just let prices fall and all rupee debt reduce accordingly, since nominal charges would remain the same. This option would not only be unfair to the country, it is also prohibited by a 2016 policy that requires RBI to maintain a cap on price levels. So that too much money doesn’t chase away too few supplies and inflate everyone’s bills, the availability of credit may soon need to be tightened. Since the RBI is the debt agent of the state, it must also try to keep government borrowing low, which is an objective in conflict with controlling inflation, as obtaining ‘Cheaper Debt Eases Credit. Under fiscal dominance, RBI is much more likely to impose G-Secs on captive buyers at inflated prices, delivering a yield curve with rates below what inflation and market demand would warrant. Relieved of this work and this conflict, RBI could focus more narrowly on its task of protecting the real value of the rupee. This reform would also make corporate bonds easier to value

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Tana T. Thorsen