Borrowing plan: States edge out corporates from bond market

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Rising state government borrowing has depressed sentiment in the market with investors staying away from investing in central government securities for fear of rising valuation-linked losses.

The supply of state paper, considered high-quality because of government backing, is raising yields across bonds. It has pushed up sovereign bond yields and, as a result, threatens corporate bond yields. Incessant supply means the private sector is elbowed out from the market by states. At a time when banks are not lending freely to companies, such crowding out does not augur well for them.

"State bonds are an alternative to corporate bonds for investors. The way states are borrowing, it would be more than the Centre's total borrowing in a few years. It will raise the borrowing cost for corporates across tenures," said Soumyajit Niyogi, associate director, Indian Ratings and Research.

In 2017-18, states collectively borrowed Rs 4.2 trillion from the market, while the central government borrowed Rs 5.9 trillion. In 2013-14, states had borrowed Rs 1.96 trillion, whereas the Centre borrowed Rs 5.64 trillion. 

Borrowing from the Union Government has remained stable over the years as fiscal consolidation targets take centre-stage. States have been increasing their borrowing size every year. Many states are issuing separate bonds for power distribution companies. Also building stress on their finances, a large chunk of the borrowing is used to service old debt, which in the longer scheme of things could become unsustainable, say economists. 

There is a theory doing the rounds in the bond market that states are borrowing on behalf of the Centre, while the latter has managed to keep its first-half borrowing programme lower than the market expectation. 

"The numbers are an illusion. The states are borrowing high so that they can participate in non-competitive bidding for treasury bills and pass on the money to the Centre," said a dealer.

For example, in the previous auction for 91-day treasury bills of Rs 70 billion, two non-competitive bids were received for a massive Rs 58 billion. Both were accepted. Such non-competitive bids can be made by large institutions or states.  

According to the first quarter's borrowing calendar, states plan to borrow Rs 1.2 trillion, against their practice of keeping the first quarter borrowing limited to Rs 600-700 billion. The first quarter is kept usually lighter, whereas borrowing swells in the last quarter. 

When the Reserve Bank of India (RBI) recently opened up more space for foreign portfolio investors (FPIs), state development loans (SDL) were left out. 

Instead of increasing space in SDLs, or bonds issued by states, RBI reduced the space reserved for the long-term sub-category to Rs 71 billion, from Rs 136 billion earlier. The amount freed was transferred to the government bonds limit. 

The most obvious reason is that investment in the long-term category is zero. Long-term investors do not seem interested in SDLs. 

Data from National Securities Depository shows total investment by FPIs in SDLs is Rs 56.99 billion, against the total allowed of Rs 315 billion. The entire amount has been invested by portfolio investors and, nor are local investors excited about SDLs. 

"Perceived liquidity in government securities market is more than SDLs. FPIs don't want to invest in anything that cannot be sold readily," said the treasury head of a foreign bank. 

States don't maintain their accounts properly and details are almost never obtainable except for what the states put out in their annual accounts. FPIs don't always trust those accounts.

A rating agency executive, who tracks state finances, said what states decide at the start of the year is not what they end up borrowing. The amount that gets issued in the market is usually higher. 

One more factor that goes against SDLs is that states borrow in multiple securities' identification numbers. There is no concept of reissuance, which prevents creating a volume in a particular bond. 

RBI is trying to change this. It said states would be linked to market rates and fiscal condition. 

In its October 2017 policy, RBI said it would announce measures to develop the SDL market by consolidating state government debt through reissuance and buybacks of SDLs. The central bank plans to publish high-frequency data on states and let market forces decide on yields. This will make it more difficult for weaker states to raise cheap money. They will have to compete with corporates to raise funds. 

Currently, the spread between a 10-year SDL and a 10-year government securities is 65-75 basis points. If the borrowing is linked to the fiscal condition, spreads for some states could be much higher, whereas some good states may borrow at a cheaper rate than now, said bond dealers.

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