India Inflation Fight Hampered as Debt Role Hinders RBIKartik Goyal
The biggest critic of India’s $100 billion budget deficit is also one of the largest purchasers of the debt that finances it: the central bank.
The Reserve Bank of India faults government expenditure for stoking inflation even as its sovereign-bond holdings have risen to $91 billion from negligible amounts in 2008. While it has a mandate for price stability -- like counterparts in the U.S., Europe and Japan -- the RBI has another charge its peers lack: ensuring the government achieves its borrowing program.
The RBI’s ability to damp the cost of living may be further curtailed by record government borrowing and spending next fiscal year, stoking demand and prices in an economy facing supply constraints. The inflation threat adds pressure on India to join nations from the U.S. to Brazil in separating debt management from inflation control. A bill to do so has been sent for cabinet approval, two Finance Ministry officials said.
“As the government’s debt manager, the bank can’t say, ‘I won’t go ahead and facilitate this borrowing you need,’” said Rajeev Malik, an economist at CLSA Asia-Pacific Markets in Singapore, who has analyzed India’s economy for a decade. “By continuing to finance the large fiscal deficit, the RBI has made its own fight against inflation more challenging.”
The bank holds about 27 percent of the sovereign bonds issued since 2008, when its holdings stood at $2.5 billion, according to calculations by Bloomberg News based on RBI data.
The deficit will widen to 5.2 percent of gross domestic product in the 12 months to March 31, 2013, from 2.5 percent in 2008, budget documents show.
Wholesale-price inflation has averaged 7.5 percent in the past year and the consumer gauge about 10 percent, among the highest in Asia. The RBI has previously said its threshold level may be about 5 percent. A report today showed consumer prices rose almost 11 percent in February from a year earlier.
The Reserve Bank is prohibited from buying notes directly from the government, instead acquiring them from investors through so-called open-market operations. Those purchases don’t primarily seek to facilitate government borrowing, according to the monetary authority.
“This has nothing to do directly with the government borrowing program,” central bank Deputy Governor Harun Rashid Khan said in an interview on Feb. 7. “Government borrowing management is the by-product of OMOs. We do it to address the liquidity shortage.”
Khan was referring to cash shortages in the banking system.
Governor Duvvuri Subbarao said last year if bond purchases aim “to help out a fiscally vulnerable sovereign or to reduce the cost of borrowing for the sovereign, central banks could end up holding price stability hostage to sovereign-debt concerns.”
He cut the benchmark interest rate to 7.75 percent from 8 percent in January to counter the weakest economic growth in a decade, while flagging the need for fiscal consolidation.
“The high level of fiscal deficit and higher revenue expenditure by the government may add to the inflationary process,” the RBI said in a Jan. 28 report.
Legislation for a reform pending since 2007 to set up a separate debt office has been sent to the cabinet for approval, two Finance Ministry officials with knowledge of the matter said this week, asking not to be identified as the information isn’t public.
The bill would still need the consent of lawmakers, leaving the minority Congress Party-led ruling coalition needing allies to back the legislation.
“This reform is tricky because the Reserve Bank has the expertise in helping the government achieve heavy borrowing,” said Rupa Rege Nitsure, an economist at Bank of Baroda in Mumbai.
Most of the 34 advanced nations in the Organization for Economic Cooperation and Development established debt offices in the late 1980s and early 1990s, according to a report by India’s Finance Ministry. Emerging markets such as Brazil and South Africa also have such units, the report said.
“Even though the RBI says that bond purchases are aimed at liquidity operations, the unfortunate consequence is that they end up helping the government’s borrowing,” said Amol Agrawal, an economist at STCI Primary Dealer Ltd. in Mumbai.
Open-market operations at times lead to the “de facto monetization” of the budget gap, the bank’s economic research unit said in a March 4 report, which stressed the views in the paper were those of the contributing staff of the department, not the monetary authority.
While other major central banks aren’t charged with aiding fiscal borrowing targets, they do buy government debt. The Federal Reserve holds $1.76 trillion in Treasuries, and the Bank of Japan uses government debt buying as its key policy tool. The European Central Bank purchased securities of debt-laden euro area borrowers to help stem the region’s crisis.
India’s Finance Minister Palaniappan Chidambaram boosted spending on the poor in the Feb. 28 budget to woo voters before elections due by 2014.
He is relying on higher tax revenues, asset sales and subsidy cuts to trim the widest fiscal gap in major emerging nations to 4.8 percent of GDP in the year through March 2014.
The rise in government spending of about 16 percent to 16.7 trillion rupees ($307 billion) in the period threatens to fan price pressures.
The yield on the benchmark 8.15 percent bond due June 2022 surged to 7.87 percent on budget day from 7.80 percent as Chidambaram unveiled gross borrowing of 6.29 trillion rupees.
The onus is on the central bank to buy more bonds or else yields will go “through the roof,” said Ganti N. Murthy, who oversees about $1 billion as head of fixed-income investments at Peerless Funds Management Co. in Mumbai.
While the increase in the budget gap since 2008 initially could be explained as a response to the global credit crisis, keeping it high for the fifth straight year has brought instability to Asia’s No. 3 economy, Morgan Stanley said in a Feb. 18 note.
Chidambaram now seeks a 3 percent deficit by 2017, part of wider policy changes by Prime Minister Manmohan Singh to repair fiscal damage, avert a credit-rating downgrade and return growth to the average of about 8 percent in the past decade.
The economy will expand 5 percent in 2012-2013, the least in a decade, sapped in part by cooling investment, forecasts from the statistics agency show. Industrial production rose 2.4 percent in January from a year earlier, rebounding from a contraction, a report showed today.
The prospect of a subdued recovery may add to the challenge of funding extensive welfare spending in a nation where more than two-thirds of the 1.2 billion population lives on less than $2 per day, according to World Bank poverty data.
“You can crib, you can cry,” former RBI head Y.V. Reddy said in December, when Subbarao asked in a panel discussion if fiscal policy dominates monetary policy. “It’s always been so.”
Elsewhere in Asia, Philippine exports unexpectedly fell in January from a year earlier, while a National Australia Bank Ltd. survey showed Australian business confidence dropped in February.
In Europe, U.K. industrial production probably rose 0.1 percent in January from the previous month, according to the median estimate in a Bloomberg survey.
In the U.S., the National Federation of Independent Business will release a report on confidence among small businesses.