RBI wants states' fiscal condition to set loan price

Issuance to happen every week rather than every alternate week to avoid bunching up

The Reserve Bank of India (RBI) on Wednesday proposed to make the state development loan market more structured, by moving the issuances towards a more market-determined pricing based on a state’s fiscal condition. 

Besides, the central bank said such issuance would be conducted on a weekly basis, instead of every alternate week, so that the bunched-up issuances could be reduced in size. 

State loans, or bonds issued by state governments, have increased in size in recent times, as states engage in farm debt waivers. The weekly issuance size frequently rises up to Rs 22,000 crore to Rs 24,000 crore, as against Rs 8,000 crore to Rs 10,000 crore about two years ago. 

This bunched-up lot puts pressure not only on state bonds, but also leaves the market dry for other bond issuers. State bonds are considered quasi-sovereign and are therefore in high demand. However, the issuances are highly fragmented and so the central bank proposed the bonds outstanding should be consolidated to improve liquidity. 

Such consolidation already happens in government securities. 

“Consolidation of state government debt will be undertaken to improve liquidity in SDLs through reissuances and buybacks, so as to even out redemption pressures and elongate residual maturity,” the central bank said in its policy document. 

The RBI also said high-frequency data relating to finances of state governments available with the bank will be disclosed on its website.

In a post-policy conference, RBI Deputy Governor B P Kanungo said the heavy issuance of state development loans “has given rise to concerns of elevated supply and adverse impact on yields”. He added the weekly auctions should have “salutary impact on yields as issuance sizes will be smaller and issuances will be evened out, thereby it will be more palatable to the market”.

Bond dealers said while yields won’t come off substantially by this, but an unnecessary spike in yields can be avoided by this exercise. 

To contain the rollover risk, the RBI will go for active consolidation of SDLs through buybacks, switches and re-issuances. 

“It is also important that the auction of the state development loan, given the increasing size of SDLs, is sensitive to the fiscal position of the individual state. This helps financially sound states to borrow at a cheaper rate and prevents cross-subsidisation,” Kanungo said. 

The present SDL issues are not indicative of the risk estimate of various states, so the RBI will allow necessary steps in this regard in the next 12 months in a calibrated manner.  

“To start with the high frequency data related to state finances that is available with us will be displayed on our website in a standardised format for comparison,” Kanungo said.

According to bond dealers, frequent issuers with bad finances always get punished by the market by pushing up yields, but a structured way of knowing state finances would help the market immensely. 

The yield difference between two states would still be unlikely to be very wide considering they are government papers.