## Monday, January 18, 2016

### Assessing RBI's medium-term debt management strategy

by Radhika Pandey and Smriti Parsheera.

The international community has long highlighted the importance of a sound and transparent public debt management (DeM) strategy. Its objective being to set out the plan for achieving an optimal debt portfolio that minimises costs while accounting for associated risk factors. The Reserve Bank of India (RBI) has made a welcome move in this direction by publicly articulating the medium term debt management strategy for the three year period from 2015-18. Some key features of the strategy include adherence to a transparent debt issuance calender, elongating the maturity of the debt portfolio, undertaking buybacks and switches for effective liability management and taking steps to improve the liquidity of the government securities market.

The World Bank's Debt Management Performance Assessment Tool (DeMPA), which consists of a comprehensive set of indicators used to assess the strengths and weaknesses in government DeM practises, is a useful starting point in thinking about this issue. The DeMPA identifies the DeM strategy document as being an important component of the assessment toolkit and advocates that it should meet the following requirements:

1. Description of the market risks being managed (currency, interest rate, and refinancing or rollover risks) and historical context for the debt portfolio;

2. Description of the future environment for DeM, including fiscal and debt projections; assumptions about interest and exchange rates; and constraints on portfolio choice, including those relating to market development and the implementation of monetary policy;

3. Description of the analysis undertaken to support the recommended DeM strategy, clarifying the assumptions used and limitations of the analysis;

4. Recommended strategy and its rationale.

The RBI's strategy document also tries to base itself on these parameters. For instance, it begins with an assessment of the current debt profile of the government and then sets out the future strategy adopting the three broad pillars of low cost, risk mitigation and market development. The document however falls short of achieving a level of analysis that would meet the highest quality standards contemplated in the DeMPA. For this, the DeMPA requires that the strategy should ensure that the target ranges for the risk indicators are based on a comprehensive analysis of costs and risks - identifying the vulnerability of the debt portfolio to shocks in market rates - and these analyses are clearly described, clarifying the assumptions used and limitations of the analyses.

Analysed against this background we find that the strategy document in its current form suffers from certain flaws.

Scope limited to internal debt: The strategy is incomplete in that it has been prepared only for the country's internal debt and within that for the marketable debt of the Central Government. It is missing on two key components that are a part of the government's overall liability position: external debt and liabilities in the public account (i.e. National Small Saving Fund). The strategy also does not take into account contingent liabilities. There are close inter-connections between contingent liabilities and debt management. The government may guarantee a loan, but it will only be liable to make the payment if the recipient of the loan defaults. In such situations the government will have to assume the responsibility of paying the outstanding debt. Invoking of guarantees can therefore have an important bearing on the risk assessment of the debt portfolio of the government. This problem is, in turn, related to the lack of a unified Public Debt Management Agency, which would be able to take a full view of India's debt management problem.

Weak on forward looking analysis: A public debt management strategy must be set in a forward looking framework. The strategy document makes a point that external debt is being ignored on the ground that it forms a very small proportion of the total debt portfolio. This is a fallacious argument because if no analysis is made of the cost-risk trade-offs between external and domestic debt for the medium-long term then how can it be determined that the external debt will continue to remain "small". Similarly it has been stated that keeping currency risk low is a policy decision but the basis for this decision is not clear. It would have been desirable for such statements to be supported by an analysis of global interest rates versus domestic.

Inadequate description of underlying risks: The strategy falters in veering towards an over optimistic assessment of expected outcomes. For the baseline scenario it assumes that the "economy will record moderate to reasonable growth, a moderation in inflation as per the path projected by Reserve Bank and financial stability". It takes into account two alternate scenarios - a positive scenario in which the economy would grow at a higher pace than projected in the baseline and an adverse scenario where the reverse happens. However, the conclusion once again is that the stress tests "indicate a very low level of stress" and "the debt is stable, sustainable over medium to long run. Further, there are no short-term risks to the debt structure."

It assumes that the Government will follow its fiscal consolidation path i.e. a fiscal deficit of 3.9% by 2015-16, 3.5% by 2016-17 and 3.0% from 2017-18 onwards. It also assumes that the CPI inflation will follow the inflation targeting path adopted by the RBI. In the alternate scenario of fiscal slippage and high inflation it comes up with a higher debt-GDP and interest-GDP ratio. However, a clear analysis of the sources of fiscal and inflation shocks and the implication of deviation from the baseline scenario on the debt profile has not been demonstrated.

The strategy is weak in that it does not show a thorough analysis of the assumptions underlying its projections. For example: It says that the net market borrowing as a proportion of GDP is expected to fall from 33 per cent in 2014-15 to 31 per cent in 2017-18 reflecting fiscal consolidation. It does not explain how this will be impacted if there are deviations from the fiscal consolidation roadmap. The confidence of this statement also appears to be at odds with the Mid Year Economic Analysis which proposes a case for fiscal expansion to steer the economy on a higher growth path.

Mix of indicators for debt-sustainability and debt management: The strategy mixes debt sustainability and debt management indicators (See Table A3 of the strategy document). In a broader macroeconomic context there is merit in distinguishing between these two sets of indicators. The IMF's Guidelines for Public Debt Management emphasize that Governments should seek to ensure that both the level and rate of growth in their public debt is fundamentally sustainable, and can be serviced under a wide range of circumstances while meeting cost and risk objectives. Examples of debt sustainability indicators include debt service to revenue, debt service to exports, debt service to tax revenue in addition to what RBI has already calculated on debt to GDP and interest to GDP. In that same section the analysis of ATM (average time to maturity) is more of a debt management indicator, arising from the composition of the debt portfolio, and not of debt sustainability.

Time lag between the application of the strategy and its publication: The present strategy covers the period from 2015 to 2018 with a requirement of annual revisions. However, the RBI chose to publicly notify this strategy only on 31, December 2015, i.e. three quarters after its commencement. Going forward, if the objectives of transparency are to be met, it is essential that any revisions in the strategy for the coming period should be notified prior to its commencement.

The articulation of a medium term DeM strategy is a welcome step. The notified strategy has positive features like listing out measures to develop the domestic debt market and trying to conform with international best practices. However, it needs to be strengthened on its analytical foundations. In its present form the strategy is at best a description of the actions required to achieve a desired debt profile. Improving the analytical foundations will go a long way in improving the quality of the document to enable it to become a guidepost for achieving an optimal debt portfolio.

The authors are researchers at the National Institute for Public Finance and Policy.

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