Just do it

The governments decision to go ahead with the Debt Management Office is welcome news. This action was long due,after recommendations of various high-level committees and the detailed work of the Jahangir Aziz committee on this. As reported in this newspaper (August 21),the government seems to be going ahead now with the establishment of a DMO as a statutory body even before an act of Parliament is passed to set up one. This is welcome. The Centre now has a very large borrowing programme and despite the sharp reduction in nominal policy interest rates,the RBI,which currently manages the governments debt,has failed to bring down the governments cost of borrowing proportionately. Bond rates have inched up and it is only by forcing banks to hold government bonds through the statutory liquidity ratio and by loosening interest rate risk regulation of banks,by allowing them to hold some of these bonds in a portfolio called held to maturity,that the RBI has managed to sell government bonds. Banks are now putting pressure to allow them to hold more under this portfolio in which they do not have to hold capital according to the normal risk weightage assigned to government bonds. The source of this risk is that when interest rates rise,the price of government bonds fall,a situation in which banks would make treasury losses.

Given that the market for government bonds has not been developed,made wider or deeper,the unpleasant policy choice of reducing profitability and increasing risk in the banking sector to achieve targets for government borrowing is undesirable. The banking sector,after the global financial crisis and its impact on the real economy,is today already suffering from a higher credit risk. In such a situation,as a banking regulator,the RBI would not want to increase the interest rate risk borne by banks. When the task of managing government debt is conferred upon the DMO,the RBIs conflict of interest will be reduced and it can focus on better regulation of bank risk,including interest rate risk.

In coming months,if the RBI believes that as a monetary authority it has to tighten monetary policy,which will require raising rates,while as a manager of government debt it has to lower the burden of interest payments on government debt,the conflict will worsen. It is thus an apt time for the government to hand over its debt management to another agency which does not have the conflicts of interest that arise when an agency (the RBI) is the banking regulator and the monetary authority.