RBI tells mkts to price state bonds on financial health

The Reserve Bank of India (RBI) Deputy Governor Subir Gokarn on Friday said states with weaker finances are able to raise cheaper funds due to the market perception that state debt is sovereign-guaranteed. There was a need to bring about formal institutional fiscal discipline, he said.

“State government debt is apparently implicitly guaranteed by the sovereign. So, with or without a formal guarantee the market perceives that state debt has been fully backed,” said Gokarn. Because of this, states with weak fiscal condition don’t pay much premium compared to those with strong fiscal conditions, he added.

He was addressing the 14th Annual Money and Finance Conference organised by the Indira Gandhi Institute of Development Research here today.

Drawing lessons from the US and Canada, he said once there is credible separation and a kind of no-bailout rule, the market starts to put pressure on states to either get their fiscal house in order or pay more to borrow. He said this may act as a disciplining force for fiscal consolidation at the state level.

“So, perhaps the next step we have to look at is to bring about a rule-based sort of formal institutional discipline. How do we introduce larger elements of market-related discipline to our fiscal situation?” said Gokarn.

In a study of state finances released a week before, data showed that the net market borrowings of state governments were Rs 1.3 lakh crore from the start of the financial year up to March 6, while the amount was Rs 88,000 crore a year ago.

In terms of macroeconomic issues, he emphasised the need of fiscal consolidation. “The current macro-economy is much threatened by fiscal expansion,” said Gokarn. However, he added the government's commitment to return to a rule-based approach was an important factor in this year’s Budget.

In the mid-quarter monetary and credit policy review last month, the central bank had emphasised the need for credible fiscal consolidation in the coming Budget.

RBI is slated to announce the annual monetary and credit policy on April 17.