Posts this month
A blog on financial markets and their regulation
I wrote a column
in the Financial Express today about the reported views
of the Reserve Bank of India on the establishment of a Debt Management
Office in India.
I deliberately avoided mentioning monetary policy anywhere in the
whole column, but focused on the implications for the government
securities market and for borrowing costs.
The reported suggestion by RBI to postpone the establishment of a
debt management office (DMO) is not a good idea. An independent DMO
would help create a vibrant and dynamic government debt market, and
would reduce the government’s borrowing cost in the long run.
It is worth remembering that the development of a vibrant
government debt market is one of the few financial innovations that
have changed the course of world history. Beginning with sixteenth
century Holland, whose war for independence from the Spanish Empire
was immensely aided by its superior debt market, it has been true that
governments that have been able to borrow from willing lenders have
prevailed over those that have had to rely on forced loans.
India is today at a stage in its economic and financial development
where it needs to shift from relying on captive buyers of government
securities (the modern day equivalent of forced loans) to creating a
deep market of willing buyers for its debt. I see the DMO as an
essential and valuable step in this direction.
When a private sector company issues securities, it goes to great
lengths to assess investor appetite for different kinds of securities
and tries to tailor its securities accordingly. It works with its
investment bankers to improve the liquidity of its securities because
it knows that higher liquidity ultimately reduces the cost of its
Until the late twentieth century, governments around the world were
insufficiently sensitive to these factors and often behaved in a
distinctly investor unfriendly way. All that has changed with the
creation of professionally managed debt management offices in country
after country both in the developed world and in emerging markets.
These DMOs look at debt issuance exactly the way a corporate
treasurer looks at corporate debt issuance. They have a mandate to
borrow at the lowest possible cost, and they know that they can do
this only by making their securities attractive to investors. DMOs
around the world have worked on making the systems for issuing,
trading and settling government securities much more investor
Partly as a result of this, government debt markets globally have
evolved in depth, liquidity and sophistication. For too long, India
has relied on the easy route of placing government securities with
captive banks and insurance companies. The unfortunate side effect of
doing this is that the development of government securities markets in
India has been stunted.
Thanks to our fiscal profligacy, India has a large outstanding
stock of government securities as a percentage of GDP. This large
stock of debt provides a foundation for a very liquid and deep
market. Unfortunately, this potential has not been realised.
Other than a few on “the run securities”, most
government securities are hardly traded. Even the market for liquid
“the run securities” securities lacks diversity of
players. Government securities is largely an inter bank market. As a
result, when there is a liquidity shock to the banking system, the
government securities market becomes a one sided market. It lacks
resilience – the ability of the market to quickly return to normalcy
after a large shock.
A professionally managed DMO should change all this. In the long
run, the establishment of a DMO with a clear mandate and
accountability would help reduce borrowing costs for the government in
many ways. Unlike the RBI or the Ministry of Finance, the DMO has only
one function and a very well defined objective. This makes it easy to
measure the performance of the DMO.
When one reads the audit reports evaluating the DMOs of some
leading countries in the world, one is impressed by the clarity of
discussion on factors like the maturity composition of debt that
impact the borrowing cost of the government. In India by contrast,
there is today no real accountability for the interest cost of the
government, which is currently the single biggest item of government
Apart from lower borrowing costs for the government, there are many
other benefits from a liquid and well developed market for government
bonds. The yield curve for “risk free” government
securities is the benchmark for all other interest rates in the
The lack of a reliable and robust yield curve in the Indian
government securities market impedes the valuation and trading of
other debt securities as well. In other words, a sophisticated
government securities market is the first step to the creation of a
vibrant corporate debt market.
I believe therefore that India should not waste any time in setting
up a professionally managed DMO. What about the argument that this is
the wrong time to do so because of the large borrowing programme this
year? The savings pool in India is deep enough for the government to
borrow enough to cover its fiscal deficit in the free market. No, we
do not need “forced loans” – at least not yet.