Rebound in SDL issuance in Q4 to widen spread relative to G-Sec yields: ICRA

Credit rating agency ICRA expects the pace of issuance of state development loans (SDL) to rebound in Q4 of FY2018, after a fresh borrowing limit set by the government, led by back-ended redemption of market borrowings and possible funding of a portion of the crop loan waivers by some states.

After having compressed to 60 - 65 basis points (bps) at present, the spread between the 10-year SDL and Government of India securities (G-sec) may widen to 85 - 100 bps, if gross and net SDL issuance rises sharply in Q4 FY2018, in line with ICRA's forecast.

"Following the substantial rise in market borrowings by the state governments in H1 FY2018, some states may have exhausted a large part of the borrowing limit set by the GoI for April-December 2017, which could have contributed to the 25 percent year-on-year (YoY) decline in SDL issuance in October-November 2017. The pace of SDL issuance may rebound in Q4 FY2018, after the fresh borrowing limit for those months is set by the GoI," said Group Head, Corporate Sector Rating, ICRA Ltd, Jayanta Roy.

"If gross and net SDL issuances rise sharply in Q4 FY2018, as envisaged by ICRA, the spread between the SDL and G-sec may widen to above 85 bps from around 60 - 65 bps at present," he added.

The fiscal deficit of the state governments is mainly financed by issuing SDLs, the growth of which has charted a volatile trend so far in FY2018.

Moreover, the spreads for 10-year SDL, relative to 10-year G-sec, have displayed a mixed trend in the current fiscal. The sharp rise in SDL issuance during Q2 FY2018 raised concerns of deterioration in the fiscal position of the state governments, particularly on account of lumpy expenditure, related to crop loan waivers and pay revisions.

This contributed to a widening of the spread between the 10-year SDL and the 10-year G-sec to 76 bps in Q2 FY2018 from 68 bps in Q1 FY2018.

Subsequently, growing concerns regarding a slippage relative to the fiscal deficit target budgeted by the GoI for FY2018, as well as a decline in the systemic liquidity surplus, have hardened G-sec yields.

The 10-year G-sec yield rose to 7.21 percent in December 2017, from a low of 6.41 percent in July 2017, despite a cut of 25 bps in the repo rate in the intervening period.

In October 2017, the calendar of SDL auctions was changed to weekly from fortnightly, which has eased the concentration of supply, to an extent. This, in conjunction with the contraction in SDL issuance since October 2017, has compressed SDL spreads to 64 bps in November-December 2017.

Given the back-ended redemption of SDLs and the possible funding of a portion of the crop loan waivers by some states in H2 FY2018, ICRA expects the gross market borrowings of state governments to rise to Rs. 3.0-3.2 trillion in H2 FY2018 from Rs. 1.8 trillion in H1 FY2018 and Rs. 2.5 trillion in H2 FY2017.

As a result, the total SDL borrowing could be in the range of Rs. 4.8-5.0 trillion in FY2018, equivalent to over 75 percent of the GoI's announced market borrowing programme of Rs. 5.8 trillion in the same year.