DMO,delays

The Reserve Bank of India’s letter to the finance ministry urging the ministry to put the creation of a debt management office on hold is bad economics. India is in a business cycle downturn; its government will inevitably run a deficit,to try to compensate for a collapse in private spending and investment. Government actions must prevent the market from collapsing in on itself in a spiral of under-confidence. The Indian government’s reaction to the current downturn is no different: deficit financing. But running a deficit means borrowing; in India’s case,lakhs of crores of rupees worth.

But what does that borrowing mean? Certainly,it increases uncertainty about yields and future prices of government debt. The Indian government is already running quite a deficit; nobody expects this to come down soon. Plus,how much has been borrowed by which state entity is not transparently known to the market. The consequent uncertainty means issuing more debt will require sophisticated analysis of market conditions. Does the RBI,currently the source of decisions as to how this government debt be managed,have the in-house capability to perform that sophisticated analysis at the scale and consistency required?

Even more worryingly,even if the RBI is able to perform this function,should it,at all? Remember what else the RBI is supposed to do. It is the central monetary authority for India: it conducts monetary policy. As a debt manager,it will want the price of the debt it sells to be high — which means,by an iron law of economics,that interest rates must be low. But interest rates impact inflation expectations management — and so,as a monetary authority,the RBI has a conflict of interest. And,to top it all off,the RBI also regulates banks,to ensure the safety of the banking system — so it can then force banks to hold the government debt it issues,saying that that adds structural safety. This is a clear,unacceptable conflict of interest,which India cannot afford when it wishes to borrow at this scale. The finance ministry should disregard the RBI’s concerns,and release a timetable on the creation of a debt management office as soon as feasible.