One Step Forward

By converting special securities into marketable securities, the RBI has moved closer to tackling the issue of public debt.

The central governments decision a few weeks ago to convert a portion of the outstanding stock of special securities, which are akin to perpetuities, into that of a specified tenure came as something of a surprise. But then, the decision could well have been prompted by the lack of marketable securities with the Reserve Bank of India (RBI). In the past Y V Reddy, deputy governor, RBI, has said the Rs 1,06,000 crore worth of outstanding special securities would be converted into marketable lots in consultation with the government and used by the central bank for its open market operations.

 

Last month the government converted Rs 5,000 crore worth of special securities into 10-year paper bearing a coupon of 13.05 per cent and, last week, close on the heels of the auction of seven-year paper, the government converted a similar amount into a seven-year paper with a coupon of 12.59 per cent. These conversions will provide RBI with additional securities to conduct its open market operations, so that it could effectively tackle the overhang of liquidity in the market.

The move to convert perpetuities into marketable paper became necessary because RBIs stock of government securities has dropped from the year-end figure of Rs 1,29,590 crore to Rs 1,18,466 crore by May 30, a decrease of Rs 11,124 crore in the current financial year.

This happened because the RBI took advantage of bullish sentiments for bonds and offloaded securities to the banks.

From the point of view of the government these conversions are more than a mere book entry for the interest burden of the government has now grown manifold given that it used to pay a measly 4.6 per cent on the perpetuities.

What is, however, more important is that the vexed problem relating to the treatment of special securities has at least been partially addressed, for any strategy formulated for reducing the outstanding stock of public debt will have to tackle the issue of phasing out special securities in a gradual manner. Commenting on the two conversions, N Gopalakrishnan, managing director, SBI Gilts Ltd says, "The conversion of the special securities must be part of a concerted strategy worked out by RBI and the central government". The RBI can not be expected to continue to fund the government at 4.6 per cent for long, he adds.

The numbers

At the end of the last financial year, total liabilities of the centre accounted for about 54 per cent of GDP and the total outstanding stock of internal public debt was Rs 3,34,914.15 crore, with special securities accounting for nearly 30 per cent of this amount. Total stock of outstanding special securities was Rs 1,06,000 crore at the end of the last financial year and the final repository of these securities is the RBI. These securities bear a coupon of 4.6 per cent and are in the nature of perpetual bonds.

It is possible that the government could opt for a few more rounds of conversion during the course of this year. While the special securities are converted into those with a specified maturity, this should be done keeping in mind the repayment obligations over the years. In the recent past the government has been borrowing more by issuing securities of a short- and medium-term nature. Given that there is a hump in the repayment obligations of the government, it likely that that these securities will not be redeemed in the short run but over a period of ten years or more, says the treasury head of a nationalised bank.

Special securities are the remnant of an era of when the practice of issue of ad hoc treasury bills was in vogue. At the end of the financial year the increment in the stock of ad hoc treasury bills used to be reclassified as special securities. The ad hoc treasury bills were used to bridge the budget deficit and was an automatic source of monetisation. The system of issue of ad hocs was phased out in a gradual manner and from this financial year onwards this was replaced by the system of ways and means advances (WMA). The principal difference between the two systems was that the advances by the RBI to the government under WMA was only for tiding over temporary mismatches and not a permanent source of funding.

Reining in debt

The Tarapore Committee, which examined the issue of phasing in capital account convertibility, pointed out that the most important precondition for CAC is attaining a sustainable fiscal deficit. It had pointed out that before capital account convertibility could be ushered in reforms towards reduction of the fiscal deficit from the current levels had to begin. The Committee had recommended a reduction in the gross fiscal deficit as a ratio of the gross domestic product from the budgeted 4.5 per cent in 1997-98 to 3.5 per cent by the turn of the century.

At a time when a debate is on about the need for making the central bank independent and accountable for its actions, it is also important that the RBI should shed its role as the underwriter of the government borrowing programme. The Tarapore Committee had recommended that the centre should set up its own Office of Public Debt and the RBI should not participate in the auctions. The logic behind the Committees recommendation could have been that the ability of the central bank to pursue its charter of objective especially that of inflation targeting could have been limited if it also had to fund the centre.

On its part, when the institution of the system of primary dealers was established, the RBI has made clear its objective of shedding its role as the underwriter of the borrowing programme. In this regard it recently offered the primary dealers the option of underwriting a minimum of 25 per cent of the issue at the auction of treasury bills and government securities and linked their commission structure with their underwriting commitments. "By the turn of the century the primary dealers will be underwriting the entire borrowing programme of the central government", says a primary dealer.

Redemption problems

But then, the immediate problem on hand pertains to the practice of funding the redemption of securities through raising fresh loans. This is not only fiscal imprudence but is also unsustainable.

One might recall that the Tenth Finance Commission had recommended the a Consolidated Sinking Fund (CSF) akin to a debenture redemption reserve be set up for the public debt. The Tarapore Committee had endorsed this recommendation.

The Tarapore Committee has urged that any increase in the profit transfer from the RBI to the Government as well as the proceeds from disinvestment should be used entirely towards building up a CSF. The Committee has also pointed out that in its opinion any attempt to achieve fiscal consolidation would not be meaningful if the problem of the repayment of the public debt is not satisfactorily addressed. Hence, the institution o f a CSF is an important precondition towards fiscal consolidation. However Gopalakrishnan of SBI Gilts that the need for a sinking fund is partiall

exaggerated and is not necessarily a precondition. He is also sceptical about whether the government will opt to set up such a fund.

The Reserve Bank governor in the past at public lectures has mentioned that it does make sense to utilise the proceeds of the disinvestment process to retire public debt unless the government succeeds in reining its expenditure.

There is merit in the argument but international experience suggests that countries have grappled with the problem of reducing the stock of public debt unsuccessfully. In the Indian context the key issue will be to reduce the rate at which the stock of public debt is growing and at the same time the first step will have to be for the government to run a surplus on the revenue account.