CREATE A GOVERNMENT DEBT MARKET

FROM BUSINESS WORLD OF 26 OCTOBER 2005


Macro tasks of the day

Although the central government has carried out many important reforms in the past fourteen years, fundamental fiscal reform has evaded it. As finance minister, Manmohan Singh allowed the fiscal deficit to zoom – initially because the economy he took over needed stimulation, and later because his political colleagues loved public expenditure. Yashwant Sinha was even more profligate. Then some prudence set in, the Fiscal Responsibility Act was put in place, and the government restrained the fiscal deficit as a proportion of GDP. That prudence was largely wasted. For the new government, headed by a responsible economist and a finance minister who does not hesitate to take unpleasant decisions, has been lackadaisical about fiscal correction. It delayed the Fiscal Responsibility timeline, and has in fact shown no signs of fiscal responsibility till now.

Over in Bombay, the National Stock Exchange (NSE), set up by the financial institutions, created a seamless electronic stock market ten years ago. It began to trade government securities soon after. But this market has remained small and inactive because the Reserve Bank sabotaged it. The Reserve Bank operated its own primitive market for securities in the form of Securities General Ledger, an account book which listed all the holdings of banks and government financial institutions. Deals amongst them were made over the telephone through a cabal of brokers, and had to be reported to the Reserve Bank for entry into the Ledger. Although the electronic market operated by the NSE was far more efficient, the Reserve Bank did not allow banks and financial institutions to trade on it; so it remained illiquid and moribund.

Although the Reserve Bank’s insistence on protecting an exclusive, inefficient bond market of its own seemed perverse, it was not entirely devoid of logic. The Reserve Bank sees itself as the government’s treasurer. At a time when the government ran huge deficits, the Reserve Bank saw it as its duty to find a place to park government loans in an orderly manner. Till 1991, the task was made easy by the government’s forcing banks to keep 38.5 per cent of their assets in government securities. After central government bonds were taken out of this limit in 1993, the Reserve Bank had to persuade banks to hold such bonds. That was not difficult since most of the banks are owned by the government; but the need to “maintain orderly conditions” or, more plainly, to keep interest rates down for the government led the Reserve Bank to operate the non-transparent ledger-based market in securities.

Now, as the Reserve Bank’s Mid-Term Review pointed out, the ongoing economic boom has created buoyancy in central government revenues, and the introduction of value added tax in state government revenues; as a result, the borrowing requirements of both have declined. Further, and perhaps as a result of this reduction in fiscal stress, the Reserve Bank launched a computerized version of its securities ledger a couple of months ago. It comes close to an electronic securities market. So in effect, the Reserve Bank has built an alternative digital platform to the National Stock Exchange. The only reason for the continued existence of the latter now is that the former is not open to those that do not belong to the government family.

Having come this far, the Reserve Bank should consider the next step of creating a single market in government securities, open to all Indian persons and institutions. It does not matter whether the market is run under the aegis of the Reserve Bank or the National Stock Exchange; and given the ownership of the latter, there should be no difficulty in unifying the two.

The major advantage of doing so would be to mobilize the enormous hunger of Indians for government debt. Most savers are extremely risk-averse. Despite its stellar performance, the stock market has drawn very little savings and raised little capital. There was a time when savers were enamoured of the government Big Three – UTI, IDBI and ICICI. Now that they are pale shadows of themselves. The common saver has not taken to mutual funds in a big way. As a result, banks have made hay; they have got cheap deposits from the public – and invested them partly in government securities.

There is no reason for this arbitrage to continue – no reason to deprive savers of direct access to government securities. Looking for new business, post offices are already selling DFI loan instruments; they could equally sell government loans.

But if this is to happen, there should be no return to administered interest rates. Interest rates and bond prices should be market-determined; and for this, the broader the market, the stabler it will be, and the more money it will raise for governments. Hence the next step for the Reserve Bank must be to throw its securities market open to the public, and to create a depositary for securities.