India’s inflation fight hampered as debt role hinders RBI
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 Reserve Bank is prohibited from buying notes directly from the government, instead acquiring them from investors through so-called open-market operations.
India’s 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. 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 AsiaPacific 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 a 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 short- age.” 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.