The Centre plans to buy back costly domestic debt by bargaining with public sector banks that hold big chunks of government securities.

The finance ministry has asked state-owned banks to study the impact of selling government securities back to the Centre.

Commercial banks own over 60 per cent of all the gilts in circulation. While the average cost of government borrowings in the current fiscal hovers around 7 per cent, nearly three-fourths of the Centre's total outstanding domestic debt of Rs 5,40,000 crore (Rs 5,400 billion) carries an interest rate of over 11 per cent.

Government officials said the biggest obstacle for the Centre to pre-pay its costly debt was the absence of put and call options on gilts issued before April 1, 2002. The Centre has, for the first time during 2002-03, issued securities with put and call options.

Finance ministry officials said a concept paper was being prepared on the options before the government in pre-paying domestic debt.

"We can bargain with the banks on the sticky portfolio they carry on their books," said an official. He added that certain relaxations on provisioning norms for bad assets and honouring the government guarantee on sick public sector undertakings' debt could help the banks clean their books.

Public sector banks confirmed that the finance ministry had asked them to undertake a comprehensive study on the impact of such a move on their assets and profits. They said the Centre could pay the banks prevailing market prices to buy back costly debt.

"Paying the market price will reaffirm the current yield curve," said a senior banker. He, however, said the Centre could always try to buy back the securities at face value. "But such a move would send wrong signals because the institutions holding gilts would have to take a big hit. The government will be forced to bail them out then," he said.