More on Debt Management Office and the Reserve Bank of India
Sankt Ingen responds to my previous piece on this subject and asks what is it that the Debt Management Office can do that the RBI cannot do. Sankt Ingen thinks that I am arguing for fancy derivatives and similar stuff conjured up by bright young MBAs. No, what I would like to see is very low brow stuff.
In an institution like the RBI that does something as high brow as monetary policy and financial stability, the low brow job of peddling government bonds will never be treated with respect and seriousness. While the DMO whose sole job is to peddle those bonds will I hope do that with the same professionalism that an FMCG company brings to peddling toothpaste.
Yes, I mean that in all seriousness. The job of distributing government bonds to every nook and corner of the country is as much a matter of logistics, distribution and marketing as the selling of detergents and toothpastes. In India (and in many other countries), the system for distributing toothpastes is far superior to the system of distributing government bonds (and many other financial products).
Government bonds are a critical element of the asset allocation strategies of individuals, companies and institutions. It is a scandal that their effective distribution is restricted to a handful of elite institutions.
This lack of diversity of participants is a key factor in the underdevelopment of the government securities market in India. In equities, when domestic retail investors are selling, maybe domestic institutions are buying, and when both of them are selling, maybe foreign institutions are buying. One wishes that foreign retail could also participate and bring even greater variety to the market, but we do have reasonable diversity of players. We did not have this diversity in the late 1980s or early 1990s in Indian equities and the markets then lacked the resilience that they have now. At the slightest shock, the exchanges simply shut down the market to deal with the imbalance.
When I look at government securities market today, it is just banks (and LIC at the long end). All banks face the same liquidity shocks and markets can therefore easily become highly one sided. At a deeper level, banks are the wrong kind of buyers for long term government bonds because of the asset liability mismatch. The real reason why governments borrow from banks is the same as the reason why robbers steal from banks – that is where the money is easily available.
The government securities market today is not a market filled with investors, hedgers and speculators with diverse liquidity needs and different investment horizons. We have a crazy scheme of small savings that completely fragments the market by segregating retail investors in separate instruments altogether. Even the retail trading of government securities themselves is segregated from the inter bank market.
The biggest problem is that the RBI does not see investors in government securities as its customers at all – the banks are its wards and retail investors are just a nuisance to be segregated in a tiny and separate corner of the market. I wrote a paper on this five years ago.
I believe that with the right market design, India can and should aspire for a government securities market that is deeper and more liquid than that of the typical emerging market. I think in terms of the size of the economy, the outstanding stock of rupee government debt, the existence of a critical mass of financial intermediaries of reasonable sophistication and the abundance of finance talent in the country. Yet, the vibrancy that one sees in the equity market or the commodity derivatives market is lacking in the government bond market.
I hope that we will get a DMO with a low brow mandate of making government securities as easy to buy as toothpastes and detergents. I hope that such a low brow DMO will over a period of several years give us a deep and vibrant government securities market. This may be a misplaced hope, but hope is the last thing that I would like to lose. Anybody who hoped in the 1980s to see a well functioning equity market would have been dismissed as a day dreamer, but over two decades, this has indeed come about. Maybe we can repeat that miracle once again in the market for government securities.
Posted at 8:53 pm IST on Sun, 26 Jul 2009 permanent link
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