There were not many dissenting voices when, in early 2007, the finance ministry announced its decision to set up a separate debt management office to take over (from Reserve Bank of India) the responsibility of raising short-term and long-term debt for the Union government. The decision was in line with the recommendations made by the advisory group of the RBI on Transparency in Monetary and Financial Policy, in September 2000, to separate the public debt management and monetary policy functions of the country’s central bank. The Group had suggested that the separation of these functions should take place in a phased manner, after achieving the objective of fiscal consolidation. Indeed, the revised estimate of fiscal deficit for 2006-07 was 3.7 per cent of GDP and the Budget estimate for the following year projected a further decline to 3.3 per cent. The case for a separate debt management office got stronger with the actual fiscal deficit eventually declining to 3.5 per cent in 2006-07 and to 2.7 per cent ofGDP in 2007-08.
Since then, however, the situation has changed quite dramatically as the fiscal deficit for 2008-09 ballooned to 6 per cent of GDP according to the revised estimates. With the budgeted fiscal deficit target at 6.8 per cent for the current financial year, and a long and arduous path of fiscal correction lying ahead (the fiscal deficit target is set at 5.5 per cent for 2010-11 and at 4 per cent for the following year), the finance ministry may have lost the only strong argument it had in favour of setting up a separate debt management office. A fiscal deficit of 5.5 per cent of GDP next year (that is when the ministry hopes the new debt management office will become operational) will mean no major reduction in the volume of debt to be raised and the need for ensuring overall consistency in fiscal and monetary management will continue to be felt.
In other words, this is not the ideal time for separating the debt management and monetary policy functions of the central bank. This is quite apart from the other arguments in favour of continuing with the status quo. For instance, volatile capital inflows require foreign exchange interventions from the RBI in the form of sterilisation through issues of securities under the market stabilisation scheme. This requires co-ordination between debt management and such interventions to minimise the impact of excessive capital inflows. If the debt management office is separate from the RBI, harmonising such operations will be less easy. There is also the conflict of interest between the government’s role as a debt manager and its status as the owner of majority stakes in many banks, which subscribe to government securities in auctions. In a situation where the government controls about 70 per cent of the country’s total banking assets, a debt management office under the finance ministry might encourage undue influence to be exercised on banks’ decisions to participate in government securities auctions and thereby distort the price discovery process. Moreover, since state governments are also borrowing from the markets, divesting the RBI of its debt management functions and transferring them to the finance ministry might cause problems in Centre-state relations. It makes sense then to go slow on the creation of the debt management office, at least until such time as the government is back to a modest level of fiscal deficit.