Investor appetite for SDLs has increased, with the market size at INR1.35trn (close to 11% of GDP), annual gross issuance has increase threefold in the last four years, to around INR250bn in FY15 (INR100bn: FY11) says India Ratings and Research (IND-Ra).
SDLs are implicitly assumed to have no credit risk. In this regard, they are perceived to be similar to securities issued by the Government of India. This is evident from the fact that the risk weights assigned to the investments in SDLs by the commercial banks is zero under the Basel III and they also qualify for Statutory Liquidity Ratio requirement of banks. However SDL are priced at a premium to the G-secs yields. In fact SDLs on an average had a spread of 37bps over the government security in FY15 (70bps in FY11). While some of it is on account of liquidity premium, the remaining part could possibly be on account of credit risk. Interestingly, the spreads remain range bound across states irrespective of their fiscal position.
From the issuers' perspective, benefits of rating can range from the recognition of better fiscal performance, as also setting an internationally recognised benchmark for its credit quality. This also incentivises states to achieve fiscal discipline, the benefit of which will be reflected in states' spread differentials.
From the investors' perspective, ratings can help them better allocate their resources - where the risk-return is optimised as per their profiles and appetites. It also helps them distinguish better credit qualities - which erstwhile would be in absence of complete knowledge. A price differential driven by credit quality will also push states to disclose information in a timely manner and possibly improve the level of disclosures. In effect, credit rating for states can create a system of checks and balances in the SDL market.
Unlike the centre, states do not have the ability to print currency and SDLs are thus used to fund states' expenditure. Akin to the centre, states run revenue and fiscal deficits which are financed through multiple channels such as assistance from the centre, with market borrowings being the major source. As a result, interest expenses singularly formed 10.7% of the states' total revenue expenditure for FY15. Given the cost implications and their impact on the health of individual states, the importance of a well-developed market for state bonds is imperative.
The SDL market is an institutional driven market and has a relatively illiquid secondary market. Growing needs of states in a federal structure, as also Fourteenth Finance Commission's emphasis to give states greater autonomy and flexibility to manage their finances, have necessitated states to proactively lay out their fiscal roadmaps to ensure a balance between the need to achieve growth and that of fiscal consolidation.
RBI recently allowed foreign portfolio investors to invest into SDLs in a staggered manner and the same has garnering a strong response. Ind-Ra believes this market segment could be of interest and relevance to several investors as an alternate to G-secs.
Powered by Capital Market - Live News
