Harun R Khan: Recent global developments - implications for debt
management in emerging markets and developing countries
Based on the inaugural address by Mr Harun R Khan, Deputy Governor of the Reserve Bank
of India, at the 2nd Meeting of SAARC Public Debt Managers' Forum, hosted by the Reserve
Bank of India, Jaipur, 6 December 2013.
* * *
The speaker acknowledges the contributions of Sunil Kumar of the Reserve Bank of India.
1. A very good morning to all. A warm welcome to Governor, Central Bank of
Afghanistan, Deputy Governors of Bhutan and Nepal, officials from Government of India,
executives of SAARC Secretariat and member countries and my colleagues from the
Reserve Bank of India to the beautiful city of Jaipur. My special welcome to chairpersons and
speakers for having accepted our invitation to share their expertise/knowledge on different
areas of debt management with all of us.
2. A little bit about the city of Jaipur. Jaipur is an important city of India with a rich
heritage and history. It is the capital of the state of Rajasthan and is fondly termed as the
Pink City. Jaipur has a timeless appeal in its colourful bazaars with delightful handlooms and
trinkets. Beautifully laid out gardens and parks, attractive monuments and marvellous
heritage hotels, once the residence of Maharajas, not to mention the ambling camels and
cheerful people in multi-hued costumes make Jaipur a tourist's paradise as part of the
Golden Triangle tourist circuit along with Delhi and Agra. You could explore and experience
all these during the social activities and the city tour.
3. Now coming to the event, which has brought the public debt managers and experts
from the SAARC countries under one roof to exchange knowledge with one another, I am
sure it will be a memorable one for all the delegates. Sri Lanka has the distinction of being
the first SAARC nation to organize the SAARC Public Debt Manager's meeting in Colombo
last year and this being the second meeting of the forum. This Forum, as I recognize, brings
together the senior debt managers from central banks and Ministries of Finance of all the
SAARC countries to discuss and deliberate on latest policy challenges, compare notes on
best or leading practices and, more generally, to share experiences among practitioners.
Looking at the theme of this conference, "Sovereign Debt Management in Emerging Markets"
and its detailed programme, I see that we intend to cover a wide range of topics/issues
which, inter alia, include the challenges posed by global developments for public debt
management and its linkages with macroeconomic stability and strategies thereof, lessons
and outcomes of product innovations as also market infrastructure for government bonds.
Given the span of issues intended to be covered during the conference, I would like to make
a few general observations with focus on the challenges posed to policy making for
Emerging Market and Developing Economies (EMDEs) in the area of debt management in
the context of recent developments in the global economy as well as the way forward to
manage the uncertainties which have become certainty in an interconnected world.
Recent global developments: risk and challenges for EMDEs
4. The current Public Debt Management Forum takes place against the backdrop of a
still weak global economy, especially in Advanced Economies (AEs) where growth in some
countries still remains weak. Indeed, the global financial crisis has dramatically changed the
policy environment. Risks - old and new - continue to dominate the outlook and new policy
challenges are arising not only in macroeconomic policy but also in debt management
framework, both for EMDEs and also the AEs.
5. Going a little in the past, we know the world economy was ambushed with full blown
financial crisis in 2008-09 and the growth in world economy had slowed down markedly from
5.4 per cent in 2007 to 2.8 per cent in 2008 and further to around half a per cent during 2009.
The crisis which erupted in the US and other AEs with unravelling of sub-prime crisis soon
traversed to the EMDEs, reflecting elevated inter-connectedness among countries in the
backdrop of increasing external openness and cross-border financial flows. The growth in
EMDEs also declined from 8.7 per cent in 2007 to 2.7 per cent during 2009. The
governments across large number of countries had undertaken fiscal stimulus measures in
order to contain the slowdown and revive growth, and this translated into steep increase in
the government market borrowing. It was really challenging for debt managers, especially in
EMDEs to complete the increased market borrowing in a non-disruptive manner.
Subsequently, the European sovereign debt crisis unfolded in which the elevated debt levels
coupled with sub-optimal debt structure in some of the European countries (i.e. high share of
short-term debt and greater share of foreign investors' holding) triggered a major rollover risk
for these countries (Chart 1).
6. The contagion emanating from the European sovereign debt crisis coupled with
elevated market borrowing requirement amplified the challenges for debt managers in
EMDEs, particularly for those who rely significantly on international capital markets for their
government market borrowing. The challenge for debt managers in many EMDEs was on
two counts: first, heightened volatility and uncertainty in the domestic financial markets due
to capital flow reversals triggered by deleveraging of foreign investors; and second,
increased exchange rate volatility mostly leading to sharp depreciation of the currency. The
countries, which had scope to issue short-term debt due to elongated maturity structure and,
at the same time, depended largely on domestic debt, could weather these challenges by
issuing larger quantum of short-term debt domestically. On the other hand, the countries
having short maturity debt structure were exposed to greater rollover risk. In the above
backdrop, one could reasonably argue that optimal debt structure could help debt managers
to meet challenges posed by the contagion from the global financial turmoil with less pain.
Therefore, the debt managers need to pursue the optimal debt structure instead of a
suboptimal debt structure guided by the narrow and short-sighted objectives. I am sure that
deliberations in the conference would focus in-depth on what should be the optimal debt
structure compatible with local conditions.
7. The world economy bounced back from a contraction of around half a per cent in
2009 to an expansion of 5.2 per cent in 2010. The global recovery was supported by fiscal
stimulus measures along with accommodative monetary policy often backed by
unconventional policy measures, pursued by various countries. As part of the unconventional
measures, some of the countries, such as, the US, the UK and the European Union
conducted large scale Assets Purchase Programme (APP) in order to bring normalcy in
financial markets and improve the credit flow to the real sectors. These measures resulted in
capital flows back to EMDEs, as net financial flows (private), which had declined from
US$ 698 billion in 2007 to US$ 282 billion during 2009, increased to US$ 572 billion in 2010.
Although the US is still continuing with accommodative monetary policy, the net financial
flows to EMDEs declined substantially to US$ 237 billion in 2012. Some of the AEs are
expected to withdraw the accommodative monetary policy and the prolonged period of strong
capital flows may come to an end and EMDEs may face a transition to more volatile external
conditions. An example of such volatile external conditions was experienced by EMDEs in
the recent past following the announcement by the chairman of the Federal Reserve in May
2013 about the expected tapering of APP by year-end and complete exit by mid-next year.
The Federal Reserve, however, decided subsequently to continue with APP and pursue
highly accommodative stance of monetary policy. But no country can be complacent, as APP
by the Federal Reserve is not perennial and it has to come to an end sooner or later
depending on economic activity and labour market conditions. In the meantime, debt
managers in EMDEs should formulate strategy and develop buffers to deal with such an
eventuality.
8. The strong, yet volatile capital flows present central banks and debt managers in
EMDEs with unusual challenges and also raises the threat of a sudden drying-up of market
liquidity in key segments. We are aware that large capital inflows engender benefits as well
as costs. The good news is that strong fundamentals in many EMDEs have reduced their
vulnerability along with much improved external positions and the buffers provided by
accumulated forex reserves all played a part in this outcome unlike the past experience.
Although the positive impact of capital flows and commodity prices are often quoted as
catalyst for growth in EMDEs, it needs to be noted that there are many other drivers of
longterm growth in EMDEs which are domestic in nature, e.g., sound macroeconomic
fundamentals, demographic advantage, high savings, etc. External factors could support
growth only in the short-term. Thus, the recent global developments have brought into sharp
focus the key interconnections between the financial, economic and macroeconomic policy
constraints. Sound domestic macroeconomic fundamentals are essential and will become
the differentiating criteria blurring the current distinction between the AEs and the EMDEs. In
this context, the session on "Public Debt Management and Macroeconomic Stability" will
throw light on the new and complex interactions between public debt management and
macroeconomic policies. This kind of interaction provides an opportunity for mutual
discussions in the interest of fostering further market development.
9. The resilience of EMDEs to date is a notable feature of the recent crisis unlike the
past crises. This could be because the crisis did not emerge in EMDEs, and as also various
initiatives in emerging economies have focused on the reform of debt management practices
and the development of domestic debt markets supported by sustained improvements in
macroeconomic and financial sectors over the past decade. Review of experiences with
public debt management and how debt managers coped with the impact of this global shock
in the form of various policy responses in primary and secondary markets would be
informative. I think the session on "Global Developments and its Impact on Public Debt
Management of Small Emerging Market Economies" would elaborate the impact on
emerging economies more succinctly.
10. Another challenge faced by EMDEs during the recent global crisis and subsequent
sovereign debt crisis was maintaining the fine balance between price stability, debt
sustainability, and financial stability. This has also been phrased as "New Trilemma" by our
former Governor Dr. D. Subba Rao. Policies pursuing these three objectives are intertwined
in several ways and impact other objectives often in unintended manner. It may be
underlined that interaction and impact of these policies, however, may be different during
crisis periods from normal periods. There could be two way impact of the policies pursuing
these objectives, e.g., policy aimed at price stability may adversely impact financial stability
and debt sustainability and vice versa. To elaborate further, increase in interest rates to bring
down inflation and ensure price stability may impact debt sustainability/ financial stability
adversely. On the other hand, the policies pursued for debt sustainability, such as,
monetisation by the central bank and write-offs, may be detrimental to price/financial stability.
Such potential conflict does not imply that these objectives cannot be balanced
simultaneously. To add another dimension, policies pursuing the above three objectives may
also impact the growth objective and interplay these objectives could be called as "New
Quadrilemma". For example, the debt consolidation pursued during slowdown phase may
turn fiscal policy pro-cyclical impacting growth adversely. Hence, it is imperative that proper
balance is struck among these objectives through optimal policy and institutional choices.
The Indian experience
11. Coming specifically to the Indian context, I would like to mention that the impact of
the global financial crisis also traversed to India. Fiscal stimulus measures were undertaken
to mitigate such impact and, accordingly, the Government market borrowing increased
steeply (i.e. about 83 per cent higher market borrowings over the budget estimates of
2008-09 and about 65 per cent higher in 2009-10 over the previous year). At the same time,
the financial markets became highly fragile and turbulent, reflecting an elevated
interconnectedness and global integration. The liquidity in the system had dried up due to
large capital flow reversals on account of deleveraging by foreign investors from EMDEs and
an environment of uncertainty and general risk aversion in financial markets prevailed,
posing a daunting challenge for the debt managers in the central bank to complete market
borrowings in a non-disruptive manner. The elongated average maturity to life (AML) of the
debt, however, provided a reprieve and the debt management strategy involved issuance of
large short and medium-term debt keeping in view the market conditions. In fact, India had
one of the highest AML of the Central Government securities and, thus, there was ample
scope to manoeuver the maturity profile without compromising on the prudent degree of
rollover risk (Table).
12. A combination of other measures, involving monetary easing and the use of
innovative debt management tools, such as, synchronising the Market Stabilisation Scheme
(MSS) buyback auctions and open market purchases with the government's normal market
borrowings and desequestering of MSS balances were also undertaken. By appropriately
timing the release of liquidity to the financial system to coincide with the auctions of
government securities, the Reserve Bank ensured a relatively normal liquidity conditions in
the markets and in the process facilitated smooth conduct of the government's market
borrowing programme. This, in fact, underlines the importance of high level of co-ordination
between monetary policy and debt management policy for successful completion of market
borrowings during volatile periods. During turbulent times, there remains a strong possibility
of agencies pursuing their narrow objectives and in the process undermine coordination. In
India, there is inherent seamless coordination on these policies by virtue of both policies
being entrusted with the central bank. Reserve Bank of India, in co-ordination with the fiscal
policy makers in the Ministry of Finance could manage the huge borrowing programme
without unduly impacting the financial markets. Such monetary and fiscal co-ordination was
at display not only during the height of global crisis but throughout the recent period of
market turbulence.
13. Post global crisis the debate has resurfaced about institutional location of the debt
management functions; whether it should be with central bank or with a debt management
office. In this regard, it may be pertinent to mention that one size does not fit all. In India,
although process of separating debt management from the central bank is being discussed
seriously, in the given circumstances of large size of market borrowings and the level of
market development, it is felt that such separation at the current juncture could be
suboptimal. Post-crisis learning do suggest that to achieve public policy objective of ensuring
growth, price stability and financial stability, co-ordination between monetary policy, fiscal
policy and sovereign debt management is critical. There is inherent synergy of monetary
policy and sovereign debt management strategy and if they operations remain with the
central bank. There is, thus, a strong view that the present arrangements for debt
management by the central bank in co-ordination with the Government need not be
discontinued, especially when the fiscal deficit remains elevated warranting large market
borrowings without disrupting financial market stability.
14. The May 22, 2013 talk of tapering by the Federal Reserve had led to turbulence in
the external conditions and it spilled into the domestic debt market. The Reserve Bank of
India had to increase the short-term rates in order to contain volatility in the foreign exchange
market. The overnight call rate increased from 7.21 per cent on July 15, 2013 to 13.46 per
cent on September 7, 2013. The hardening of the short-term interest rates got transmitted to
medium and long-term yields eventually. The 10 year G-Sec yield, for instance, increased
from 7.60 per cent as on July 15, 2013 to 9.27 per cent as on August 2013 (Chart 2).
15. Besides steep rise in yields that was largely attributed to liquidity tightening, the
volatility in bond yield market heightened and this led to reduced demand for G-Sec. Thus,
heightened volatility became a worrisome factor for debt managers who in such situations
could be forced to issue debt which may not be in alignment with the optimal debt structure
and thus, the same may aggravate various risk parameters. In this context, it may be
pertinent to underline that volatility in G-Sec market has subsided significantly after the
Reserve Bank announced reversal of temporary policy measures starting September 20,
2013. Another positive development is that long term foreign investors' confidence in the
Indian currency appears to be increasing lately and this is likely to translate into increased
demand for G-Sec. I am certain that discussion in the session of "Debt Management
Strategy" would throw more options for the debt managers to deal with turbulent and fragile
market conditions. Furthermore, the session on "SAARC Country Experiences" would enable
participants to know about each other's debt management practices and help in further
improving their practices. Indian experience shows robust state of the art financial market
infrastructure could be a source of resilience to the government bond market. It is in this
context, the session on "Market Infrastructure in G-Sec" which would closely look into the
regulatory structure, developments in primary and secondary market infrastructure and would
provide us useful lessons for building safe and efficient market infrastructure.
16. The debt management strategy in India has been continuously striving to expand
the bouquet of instruments in order to broaden the investors' base for achieving the debt
management objectives. Though the extant bouquet of instruments includes fixed rate
nominal bonds, zero coupon bonds, floating rate bonds (FRBs), and the proposed inflation
indexed bonds, the share of linkers in total issuances remained below five per cent. The debt
management strategy has been exploring the idea of issuing sovereign bonds in international
capital markets but as risks associated outweigh the benefits and thus, no such issuance has
been contemplated. Some EMDEs which issued such bonds faced problems during the
recent crisis period. The session on "Product Innovations-Sovereign Foreign Currency
bonds, IIBs Lessons and Outcomes" would be able to provide further insights on the benefits
vis-à-vis risks associated with new products, especially with respect to EMDEs.
17. Some of the major take-away from the Indian experience with regard to debt
management during the recent crisis period are:
• Elongation of maturity during normal times provides enough headroom to the debt
managers to deal with unprecedented volatile times like recent global crisis as debt
managers can weather the turbulence by operating at the short to medium term on
the maturity curve;
• In an uncertain environment, the usage of combination of instruments, such as, fixed
rate bonds, T-Bills, FRBs, etc. catering to the demand of divergent market
participants plays a paramount role in debt management strategy;
• Continuous dialogue/interactions with market participants to know the pulse of
market are essential for formulating issuance strategy. In India, a bi-monthly
meeting is convened with Primary Dealers (PDs) and other market participants to
gauge their demand for various instruments and seek their feedback on policy
choices;
• Better communication of the debt management policy to market remains pivotal to
avoid uncertainty in the minds of investors;
• Institutional arrangement for debt management need not follow "one-size-fits-all"
approach and, in fact, in countries having huge government borrowing requirements
the deeper involvement of the central bank is imperative for maintain balance
between different policy choices for price stability, debt sustainability, financial
stability and growth objective; and
• Government bond markets should be developed domestically in terms of investor
class, instruments, infrastructure, intermediaries and innovations and may be
opened up to foreign investors in a calibrated manner to broaden the investors' base
without unduly exposing them to the risks of sudden stops.
Conclusion
18. Going forward, the challenges faced by debt managers remain significant as greater
integration of EMDEs in international capital markets would transmit the contagion to the
domestic debt markets very fast. Further, strong capital inflows may expand the demand for
Government debt but such flows also pose sudden stop risks. I am sure this conference
would provide a hands-on policy inputs to the debt managers to help them minimise risks
and design sound debt management strategies. I hope this one and half days conference will
be eventful with many ideas and thoughts being deliberated with focus on practical
suggestions for evolving sound public debt management policies & practices.
19. Thank you for your attention.