Rbi’s Debt Management and Monetary Policy Essay Example for Free

Rbis Debt Management and Monetary Policy EssayI have shown you in class, using the IS-LM model, how the preceding(prenominal) two roles of the RBI presents a conflict between the desired positions of the LM curl and therefore the equilibrium interest rate. Some of you have expressed interest in knowing more(prenominal) about this argument. Therefore here atomic number 18 the two opposing points of view.For the motionOn this side of the debate is the government which supports an independent Debt Management Office (DMO) that is separate from the RBI. The government has received support from the Report of the privileged Working Group on Debt Management which has pointed out three conflicts that arises from the present arrangement If the fundamental depository pecuniary institution tries to be an effective debt manager, it would lean towards selling lodges at high prices, i.e. keeping interest rates low. This leads to an inflationary bias in financial policy. Second if th e Central Bank tries to do a good note of discharging its responsibility of selling bonds, it has an incentive to mandate that banks hold a large amount of government paper. Third, if the Central Bank administers the operating systems for the government securities grocery stores, as the RBI currently does, this creates another conflict, where the owner/ administrator of these systems is to a fault a participant in the market.The Percy Mistry Committee on Making Mumbai an international Financial Centre (IFC) recommended the mise en scene up of an self-governing DMO by saying that looking ahead, a sound unrestricted borrowing system for India would incorporate three elements. . . An independent Indian debt guidance office operating either as an autonomous agency or under the Ministry of Finance that regularly auctioned a large quantum of INR denominated bonds in an IFC in Mumbai. The sizing of these auctions would be substantial by world standards and would enhance Mumbais stature as an IFC. The Raghuram Rajan committee on Financial Sector Reforms (A Hundred Small Steps) has argued against RBI providing the investment banking function to the government as this involves a conflict of interest, since the government would benefit from lower interest rates, which the RBI has some control over.Investors in the bond market may in any case perceive the sale of bonds by RBI to be informed by a sense of how interest rates leave evolve in thefuture. Finally, the RBI is the regulator of banks. Banking supervision could be distorted by the desire to sell bonds at an attractive price. Media commentators have also back up the motion. See for instance Ajay Shah writing in the Business model,Ila Patnaik writing in the Indian Express, Shruthi Jayaram writing in the Financial Express, S. Narayan writing in the Mint. Also see what the Stanford Universitys Policy Brief and the Bank for International Settlements feel about this routine.Against the motionPredictably t he RBI is opposing the above views. See this Business Standard report which quotes RBI Governor Dr Subbarao as saying that Only primordial banks have the requisite market pulse and instruments to aid in making contextual judgements which an independent debt agency, driven by narrow objectives, will not be able to do. The Governor further said that in order to achieve monetary and financial stability, separation of debt care from central bank seems to be a sub-optimal choice. The case for shifting debt management function out of the central bank is made on several arguments such as resolving power conflict of interest, reducing the cost of debt, facilitating debt consolidation and increasing transparency. These advantages are overstated, Dr Subbarao said. He said market borrowings are the major source of deficit financing at state level and such borrowings are exceptional the absorptive capacity of the market.That makes it imperative to harmonise the market borrowing programmes o f the Centre and the states. Separation of the Centres debt management from the central bank will make such harmonisation difficult, Dr Subbarao added. He said even internationally, there is proximate association between the central bank with sovereign debt management for proper monetary policy and financial stability. Also see this Business Line report which quotes Dr Subbrao as saying that the learning from the recent world(a) crisis is that those systems where central bank manages government debt are more effective. When fiscal deficit is as high as it is in India, it is not only about debt management in the conventional sense. It has larger implications for liquidity management and monetary policy transmission.The balance of advantage would lie in the RBI continuing to manage public debt until fiscal deficit comes down to very comfortable levels. RBIs internal researchsupports the above view by demonstrating that interest rates have not been affected by the governments borrowin g programme (a point made by some of you in class). Some media commentators have also supported RBIs view (see this article in the Economic times). You will be amused to know that Dr Subbarao himself was an advocate of an independent DMO when he used to work for the government The confusion over this issue was evidenced by the Rakesh Mohan Committee on Indias Financial Sector Assessment which opined in party favor of an independent DMO with the chairman (an ex-deputy governor of the RBI) disagreeing with the committees viewTailpieceThe RBI seems to have reconciled to the setting up of an independent DMO but is insisting that they be in charge of running the office (so often for independence) See this report from the Financial Express. Finally you may enjoy reading this article from the Economic Times on Chidambaram vs Subbarao How conflicts between govt and RBI could lead to better policy-making.