States' borrowings see a rise

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 for banks. 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.