Debt Manager, Rate Settler, Regulator: Interrogating the Statutory Trilemma at the Heart of India’s Sovereign Debt Reforms

Authored by Kapuganti Bharath, a law student pursuing BA. LLB from Symbiosis Law School, Pune.

Introduction

The structure and governance of government securities (G-Secs) is often overlooked in terms of investment law analysis, despite its being the foundation for the domestic capital markets. The legal regime for sovereign debt in India is structurally transformative but fragmented; rather than being reformed through parliamentary legislation, it has been aggressively liberalized via executive-led actions, most notably through the Reserve Bank of India (RBI) circulars that established the Fully Accessible Route (FAR) in March 2020 and the Retail Direct Scheme in July 2021, it has paved the way for market access through the June 2026 Draft Master Direction on Secondary Market Transactions.

In this blog, it is suggested that this executive-driven liberalisation reveals an inherent institutional trilemma, one which remains unclarified by law. The Reserve Bank of India (RBI) has conflicting statutory roles: to be a monetary authority combating inflation (Section 45ZB of the RBI Act), to be a sovereign debtor who is supposed to keep borrowing costs to the lowest possible level (Section 21A of the RBI Act), and to be a banking regulator whose liquidity requirements generate demand for the debt that it is supposed to manage (Section 24 of the Banking Regulation Act).

Doctrinal Evolution

The structural genesis of the modern “trilemma” is contained within Section 21A of the Reserve Bank of India Act, 1934, in which the RBI is legally merged with the public debt as the owner and as the manager.

The Government Securities Act, 2006, was enacted to shift the market from physical promissory notes to dematerialized Subsidiary General Ledger (SGL) accounts. However, the institutional governance did not modernize, as the instruments did. The Financial Sector Legislative Reforms Commission (FSLRC) sharply contests this combination of responsibilities, arguing for a separation of the functions in the legislation in the form of an independent Public Debt Management Agency (PDMA). 

In Paragraphs 56 and 57 of the 2015–16 Union Budget Speech, the central government formally proposed the establishment of an independent Public Debt Management Agency (PDMA) and introduced enabling statutory provisions to strip the Reserve Bank of India (RBI) of its regulatory oversight over government securities (G-Secs), intending to shift trading regulation to the Securities and Exchange Board of India (SEBI). This framework was translated into Chapter VII (Clauses 118 to 142) of the Finance Bill, 2015, alongside companion amendments to the Government Securities Act, 2006 and the RBI Act. However, this sparked acute institutional friction; the RBI, under Governor Raghuram Rajan, strongly resisted the move, maintaining that separating sovereign debt management and bond market regulation from the central bank would fragment money market oversight and severely compromise its ability to manage systemic liquidity and monetary policy transmission. Facing stiff resistance from Mint Street, Finance Minister Arun Jaitley announced to the Lok Sabha on April 30, 2015 that the government was withdrawing Clauses 118 to 142 and the related G-Sec transfer provisions from the Finance Bill to allow for further stakeholder consultations. 

Consequently, the Finance Minister withdrew the PDMA clauses from the Finance Bill, 2015 on April 30, 2015. Modernization of the debt governance system has stalled; while the Reserve Bank of India Act, 1934 has undergone substantial amendments such as the addition of Chapter IIID in 2006 to regulate OTC derivatives and the 2016 framework establishing the Monetary Policy Committee - the foundational conflict remains entrenched. The market is now a 21st-century liberalized platform, yet it operates atop a governance structure where Sections 20 and 21A of the Reserve Bank of India Act, 1934 continue to legally fuse the central bank's role as the currency issuer with its conflicting obligation to manage the sovereign’s debt.

The Status-Quo Scenario: Inter-Legal Friction

This is where inter-legal friction has grown, and there are severe overlaps with regulatory arbitrage as the RBI prepares to democratize the market. 

A. Jurisdictional Friction and Cross-Statute Complexities

• National Debt Securities exchange (NDS-OM): The platform is regulated by the RBI, but the debt segments of the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) are witnessing more and more trading of G-Secs, which are subject to SEBI and the Securities Contracts (Regulation) Act, 1956. This results in a disjointed regulatory regime for a single asset class. Solving this would require removing the RBI Act's Chapter IIID should be removed and all government securities should be included in the regulatory framework of the Securities Contracts (Regulation) Act, which is managed by the Securities and Exchange Board of India (SEBI).

• FEMA and Foreign Capital: Foreign Portfolio Investment (FPI) in G-Secs is regulated under Foreign Exchange Management Act (FEMA), 1999 by FEMA. The Fully Accessible Route (FAR) has completely eliminated the FPI restrictions on certain G-Secs and has changed the law's approach from capital control to unfettered capital account openness for designated sovereign bonds. It has also enabled India to make an entry into the bond indices and brought in estimated inflows of $20 billion to $25 billion.

• Taxation Arbitrage: The Income Tax Act, 1961, often produces investor-incentive distortions – this is called taxation arbitrage. Corporate bonds may have to pay higher tax deductions at source (TDS) while the interest on sovereign bonds may be subject to different exemptions which affect the yield calculation and hence the allocation of retail and foreign funds. Moreover, the recently introduced debt mutual fund indexation benefit changes have significantly hit the tax benefits needed for retail investors to invest in sovereigns.

B. Retail Direct Scheme (RDS) breaking the market

Through the scheme, retail investors can open a Retail Direct Gilt (RDG) account directly with the RBI, making use of the Clearing Corporation of India Ltd. (CCIL) as aggregator and central counterparty to seamlessly connect retail bids to the primary and secondary NDS-OM markets. However, the scheme builds on a very conspicuous lack of norms for “suitability and appropriateness” in the RBI framework. Moreover, retail awareness is extremely underdeveloped, and even in absence of structural tax incentives in the Income Tax Act, legal and economic freedom of retail democratization is limited. 

The Institutional Trilemma: A Clash of Statutory Obligations

The current policy assumption is based on a belief that the process of market democratisation and monetary sovereignty go hand in hand. They are in a tight bind, mainly because of the conflicting statutory duties of the RBI.

A. The Rate-Setter/Debt-Manager Conflict between A. Section 45ZB and Section 21A 

The Monetary Policy Committee (MPC) is mandated to keep the inflation target under the RBI Act, 1934, Section 45ZB. But, by hiking the rates, the value of G-Sec portfolios will dip and the borrowing cost of the sovereign will rise directly, which is a direct blow to the RBI's task as the debt manager per Section 21A.

This statutory paradox or fiscal dominance is what the RBI is forced to contend with, and which it has to use legally ambiguous means to ensure sustainability of debt levels without having to make immediate inflation adjustments. The debt manager can extend the debt maturity structure of new debt issues, thus postponing the need for the monetary authority to adjust prices. This “maturity-structure channel” addresses the state's short-term legal budget in the immediate terms as per the FRBM Act, but sets the long-term interest burden of the sovereign debt in a fashion that systematically reduces the ability of the FRBM Act to function as pure monetary policy, and thereby undermines fiscal dominance. 

B. Indirect Foreign Capital and the “Impossible Trilemma” 

Introduction of India in the JPMorgan Government Bond Index-Emerging Markets (2024) has changed the legal risk matrix of sovereign debt structure. International law and economics state that it is impossible for a state to operate under three conditions: independent monetary policy, a fixed exchange rate and an open capital account. The RBI's heavy liberalisation effectively puts it under an urgent pressure to intervene in the foreign exchange spot market to deal with currency volatility. This ongoing legal and market encroachment is directly at odds with its inflation-targeting duty and is reducing domestic monetary independence to the whims of the behaviour of global index providers and foreign portfolio investors. 

C. Section 24 of the BR Act

The backbone of this whole structure is the Statutory Liquidity Ratio (SLR), which is presented in Section 24 of the Banking Regulation Act, 1949, compelling domestic banks to keep a significant part of their liabilities in G-Secs. This is what legally amounts to a “financial repression” architecture. The state establishes itself as a captive supplier of buyers to its own sovereign debt, thus displacing the private sector. This means that allied with the state-owned sector, the private corporate sector gets a paltry 43% of commercial credit, thus grossly perverting the legal allocation of money away from the most productive sectors of the economy to those of statutory priority or state-owned enterprises.

Scrutiny of Administrative Law and the fall of the Greenium

With the aggressive re-architecting of the G-Sec market by the RBI, it is including the issues of enforceability and investor protection. 

The weakness of executive-led bond frameworks is nowhere more evident than in the Sovereign Green Bond (SGrB) initiative. The sovereign has disclosure obligations with respect to the use-of-proceeds requirements, the latter being under the executive framework published by the Ministry of Finance as SGrB. However, investors have virtually no rights to accelerate repayment or initiate breach of contract litigation against the sovereign if environmental benchmarks fail. This stands in stark contrast to corporate green bonds, which are strictly governed by the SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021. In particular, Regulation 2(1)(q) defines the stringent criteria of ‘green debt security’ while Regulation 8 requires that every issuer of debt must appoint an independent Debenture Trustee. By virtue of the provisions in Regulations 40 and 44, the Debenture Trustee is empowered to oversee compliance and enforce legally enforceable contractual covenants with respect to corporate assets. As such, due sovereign immunity, a sovereign issuer cannot be compelled to undergo domestic corporate liquidation processes or have its assets seized by third parties; hence the provision on mandatory enforcement in Regulation 8 fundamentally contradicts the context of sovereign green bond issuance.

The "greenium" (premium investors pay for sustainable debt) has not been enforced through contract and empirical analysis from the first three years of the SGrB program has shown that this has resulted in the death of the greenium. By the middle of 2024, the price difference became negative, with an established negative greenium and numbers of investors subscribing to the contract dropped significantly. The market is perfectly right to not value legally unreliable policy disclosures, which shows a serious flaw with executing specialized debt instruments through an executive framework instead of a statutory covenant. 

Conclusion

When the state is examined from the narrowly investment and administration law perspective, the state is pushing the boundaries of market access while being assiduously uninterrupted in the grip of an outdated and legally conflicted governance framework. 

Recommendations:

1. The Union Government should enact standalone laws to create an independent Public Debt Management Agency (PDMA) as suggested by the FSLRC. Most importantly, it means the explicit repeal of Section 21A of the RBI Act, which has to disassociate the RBI from its dual role as the sovereign debt manager.

2. Parliament needed to eliminate the regulatory arbitrage that is present due to the fragmented regulatory framework of the G-Sec market by removing Chapter IIID from the RBI Act and repealing Government Securities Act, 2006. All the secondary market sovereign debt trading should be placed under a common regulatory framework to be regulated by SEBI under the Securities Contracts (Regulation) Act.

3. The exemptions and indexation benefits for long-term capital gains on sovereign debt should be reintroduced specifically for the retail investors, in line with the state's democratization objective, as the Retail Direct Scheme is to be genuinely viable.