More room likely for states to borrow as FM presents budget next Feb

The Centre has already begun to rejig govt savings market, reviving RBI window for retail investors, the Retail Direct Scheme this month

Finance minister Nirmala Sitharaman could pencil in more space for the states to borrow and spend in her next budget speech on February 1, 2022. The Centre has already begun to rejig the government savings market, reviving the RBI window for retail investors, the Retail Direct Scheme this month. While only central government papers are now part of the portfolio offered to the retail investors, the state papers could also be included soon. 

It will offer a larger set of investors to the state governments, but also put pressure on them to offer matching returns. The current state government papers all have a yield above the central government papers, which means the investors view them less favourably.  Kavita Chacko, senior economist at Care Ratings who tracks state papers said investors make little difference between state government papers as of now. “A rich state like Karnataka’s paper trades close to say, a Punjab”. 

The impetus to offer freedom to the states came for more than one reason. States have borrowed responsibly so far in this financial year, of course helped by the central government transferring a generous slab of money in FY22. A government release noted the total amount of compensation released to the states till November this year is Rs. 60,000 crore. "As per the decision of GST Council, back to back loan of Rs.1.59 trillion has already been released in lieu of shortfall in release of GST Compensation during the current financial year". Yet as noises within the state governments grow for more financial freedom to tax, particularly Tamil Nadu, Kerala and even Telangana and Andhra Pradesh, the centre could offer them more room instead for how they borrow and spend. Cumulatively 29 state government and union territories have borrowed Rs. 3,881 billion from the debt market during April to Nov 9, 2021, which was 16.4 per cent lower than the same period of last year (Rs. 4,641 billion) as per an Icra report. 

The other reason is the oblique support from the 15th Finance Commission. Speaking at a recent NCAER webinar on Fiscal Federalism, Commission chairman, N K Singh said there should be more room for the states to borrow. “All borrowings by the state governments are based on the comfort of their respective Consolidated Funds. This has implications for the level of expenditure they can make”.  

Also there is incipient pressure from municipal loans, the third tier of governance. States do most of their borrowings through the 10-year State Development Loans. Some of them have also begun to raise three and five year papers. Chacko said a big support to these papers come from them being eligible to be counted as Statutory Liquidity Ratio. Yet as more municipal papers will enter the debt market the competitive pressures on the states would rise even with the SLR status. The sum so far has been minuscule. The share of municipal bonds in the total debt market is only 1 percent of the financial needs of the local urban bodies. As more of them enter the market, they shall however depend on the comfort of the state level Consolidated Funds.

Even without this baggage though, the states have been prudent with their borrowing, the costs have been higher this year. The weighted average yield of SDLs in the first seven months of FY22 at 6.89 percent is 44 bps higher than in the corresponding period of FY21. States of course feel that the reform in borrowing will only happen once they get larger taxation rights. 

At the same NCAER event, P Thiagarajan, Tamil Nadu finance minister said instead of expanding, the remit of GST should be curbed. “Products which are consumed largely within the states should be taxed as thought fit by the state instead of a common GST Council rate”, he said. States should have the right to order their expenditure priorities and only then the markets would recognise the differences in outcome generated by them from their fiscal purse.