As the Centre
buys back its bonds, the state governments continue to pile up more papers in the market.
The total borrowing so far this financial year by all states
have neared Rs 3.2 lakh crore. Bond traders expect the borrowing to touch Rs 3.5 lakh crore by the end of the financial year, which would be similar to what the Centre
used to borrow a few years back. Bond dealers expect borrowings
of the states
to touch Rs 4.5 lakh crore in the next financial year. On Tuesday, 16 states
borrowed Rs 21,600 crore from the markets, against a notified amount of Rs 20,800 crore. On the same day, the central government said it would buy back Rs 20,000 crore of its bonds, using its surplus cash balance.
According to a finance commission rule, states
are mandated to keep their deficit within 3 per cent of their gross state domestic product.
There are exceptions for states
to cross the limit — for example, in case of state-guaranteed UDAY bonds
for electricity distribution companies. But, generally, states
borrow within the limit set by the Fiscal Responsibility and Budgetary Management (FRBM) Act. However, states
in the past have done better in managing their finances and the bond market has not witnessed such deluge of papers.
“The state loans
are attractive and are government backed. Therefore, it is a good opportunity for investors. But that also means private parties are squeezed out of the market,” says the head of treasury of a foreign bank. The coupon paid on state loans
are typically 50-75 basis points higher than the equivalent maturity government bonds.
As the change of stance pushed up government bond yields by 40 basis points, coupons on state loans
have also jumped about a similar quantum.
On January 24, state governments were borrowing 10-year papers at about 7.20 per cent. On Tuesday, they borrowed at 7.60 per cent.
The 10-year government bonds on January 24 was at 6.44 per cent and on Wednesday, the yields closed at 6.86 per cent. The spread maintained was 75 basis points.
The big spread is good news
According to rules, state bonds should be valued at 25 basis points above equivalent maturity government bonds, or as per secondary market yields. Since the secondary market does not exist, banks’ treasury profits get a straight boost of 50 basis points for the investment made. Banks, not surprisingly, are the largest buyer of state loans
at a time when credit growth is tepid.
However, what is good for banks
is bad for companies trying to borrow from the markets.
“SDL yields create a floor for corporate bond yields. Thus, an increase in SDL yields due to a high supply is likely to put pressure on the corporate bond curve,” India Ratings said in a report on Tuesday.