With farm loan waivers, states' market debt in FY18 to exceed Centre's

If announcements of farm loan waivers by Uttar Pradesh, Maharashtra and now Punjab are anything to go by, combined state government market borrowings may well surpass those by the Centre in the current financial year.

Such a situation would lead to a further widening of the spread between state development loan (SDL) yields and G-Secs, and could crowd out the private sector from the bond markets. The spread between SDLs and G-Secs is already higher than its long-term average.

Over the past few years, as the central government pivoted towards fiscal parsimony, state governments have turned the other way.

The Centre's fiscal deficit has declined from 4.4 per cent in 2013-14 to 3.2 per cent in 2017-18 (Budget Estimate or BE), while the combined deficits of states has risen from 2 per cent in 2012-13 to 3.6 per cent in 2015-16 (Revised Estimate or RE) according to the Reserve Bank of India's (RBI's) report on state finances. And though state deficits were budgeted to go down in subsequent years, a report by HSBC Global Research shows the fiscal position of major states had actually deteriorated.

As a consequence, gross market borrowings by state governments more than doubled, rising from Rs 1.77 lakh crore in 2012-13 to Rs 3.68 lakh crore in 2016-17. Excluding repayment, net borrowings by states have risen from Rs 1.47 lakh crore in 2012-13 to Rs 3.29 lakh crore in 2016-17.

In comparison, net borrowings by the Centre have declined from Rs 4.67 lakh crore to Rs 4.08 lakh crore over the same period.

Now, prior to the announcements of loan waivers, ICRA had estimated net borrowings by the Centre and states at Rs 4.2 lakh crore and Rs 3.8 lakh crore, respectively, in 2017-18.

But the final state borrowing figure for 2017-18 may well be higher as states will have to borrow more to finance their loan waivers even if they are staggered over a few years.

"The impact on Punjab will be maximum, with state fiscal deficit jumping by an additional 4.8 per cent of GSDP. We thus believe that states will make provisions of farm loan waiver in their Budgets in multiple years as this will not impact fiscal deficit in one single year. Even in that case we will see some worsening of fiscal deficit for some states," says a research report from the group chief economic advisor of State Bank of India

Any rise in supply of state government debt may well push up SDL yields in the current financial year, further widening the spread in of SDLs over G-Secs.

The spread has already been widening. Towards the end of the last financial year, the average spread of the 10-year SDL yields over the 10-year G-Sec yields had widened to 60-75 bps from 40-50 bps in the first half of FY17 according to ICRA. As of June 13, the spread was 70 bps.

"In our view, such loan waivers would engender an additional burden on the respective state governments' fiscal balances, necessitating the raising of further debt. This may increase the yields at which state governments raise market borrowings, and also contribute to crowding out the private sector from accessing the bond markets at competitive rates," said Aditi Nayar, principal economist at ICRA.

But Madan Sabnavis, chief economist at CARE, said, "Higher issuances of state debt are good for banks as they can park the funds there," adding, "In the current environment there is little demand for credit for investments, as such the impact on the private sector will be limited."

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