Borrowing is at the core of the budget for 2009-10. The government’s debt manager, the Reserve Bank of India (RBI), has managed with finesse the humungous offering of the Centre’s and states’ IOUs — a third more than in 2008-09, which, in turn, was a staggering two-and-a-half times the money raised the year before.
The RBI is on track to raise Rs 2,65,911 crore by September, leaving a fourth of the government’s borrowing schedule, or Rs 98,000 crore, for the remaining six months of the fiscal year. The front-loaded calendar merits itself on two counts. One, it bundles heavy government borrowing into quarters when demand for corporate credit is low. Two, this feeds fiscal expansion without raising interest rates.
On both counts, it appears, the easy bit is over. In its latest monetary policy review in July, the RBI signalled that its expansionary cycle had ended after nine months of aggressive cuts that halved short-term interest rates charged from banks. And now banks, which buy the lion’s share of government paper, are protesting they have breached the limit of gilts they can hold without taking exposure to losses from hardening interest rates. The appetite for lending to the government — which last quarter fetched Indian banks a stunning 62 per cent growth in net profits mainly through treasury operations — appears to be cooling off. The financial market, by and large, expects interest rates will begin to climb from next January although the spectre of drought may stay the RBI’s hand for a bit.
This highlights the conflict of interest inherent in the central bank’s most immediate concerns: arranging cheap funds for its principal client, pursuing a counter-cyclical monetary policy and regulating the banking industry.
If the RBI wants banks to lend more money to the government, it faces pressure to raise the threshold of their risk-free gilt holdings or continue with an easy money policy. And if it wants to pop the incipient food-price bubble it needs to raise interest rates. The roles of debt manager, monetary policy formulator and banking regulator are clearly defined — and often contradictory. Debate on splitting the RBI’s job in three has dragged on despite evidence from the West that trifurcation is the way out. The current confluence of events could be a good time as any to get on with the process.