States are forced to borrow more from the markets to meet increasing redemption pressure, which will more than double by 2026, according to the Reserve Bank of India’s (RBI) report on state finances.
This has changed the way the states view their deficit financing and is increasing their borrowing cost as supplies increased.
“Borrowing by states/Union Territories (UT)- gross and net - are fast catching up with those of the centre, with the drying up of all other sources of financing. The share of states’ market borrowing in general government borrowings has more than doubled in the last five years, also necessitated by rising redemptions,” the report said.
Instead of issuing fresh papers, states are increasingly re-issuing their bonds to improve liquidity. Reissuances picked up pace in 2019-20, with their share in overall issuances rising from 10 per cent in 2017-18 to close to 20 per cent in 2019-2016.
While net borrowings of the states/ UTs increased by about 40 per cent during 2019-20, gross market borrowings at Rs 6.3 trillion increased by 32.7 per cent, one of the highest in the recent past. For 2020-21, states had budgeted a gross borrowing of Rs 7 trillion. However, under the Aatma Nirbhar Package announced in May, states are allowed to increase their borrowing limits from 3 per cent to 5 per cent for 2020- 21. This gives the states leeway to borrow Rs 4.28 trillion more, if they meet certain reform conditions, pushing up the borrowing to as high as Rs 11.3 trillion. In contrast, the centre’s borrowing for the full fiscal is Rs 12 trillion.
The huge supply of bonds by the states and the centre has strained the bond market, but the RBI is keeping ample liquidity in the system and through other measures is trying to keep yields low. To keep state bond yields low, the central bank has also announced open market operations (OMO) purchase of state bonds as a special measure this fiscal.
Till the first half of the current fiscal, more than 60 per cent increase in borrowings on a year on year basis has already occurred, with about seven-eight states accounting for the bulk of the increase, as they suffered revenue shortfall.
States have also shifted their deficit financing and have veered more towards the markets. On average, market borrowings financed slightly more than half of the consolidated fiscal deficit of states till 2016-17. “Since 2017-18, however, the share of market borrowings has increased rapidly and is budgeted to reach close to 90 per cent in 2020-21."
The report praised states like Odisha and Haryana for being pragmatic in trying to meet their higher fiscal deficits by “using their own rainy funds without recourse to higher permissible market borrowings.” But there are states “like Gujarat and Punjab which have over-borrowed despite consolidation, with Uttar Pradesh being an extreme case - it has borrowed above 20 per cent of the budgeted amount, despite registering a fiscal surplus as against a budgeted deficit in 2019-20.”