Financial discipline may play bigger role in states’ cost of borrowing

KOCHI: The market borrowings by the states in the form of State Development Loans (SDLs) have displayed an unprecedented growth in the past few years and in order to stay competitive in the market, they may soon be required to provide high frequency data on their finances in public domain so that they can attract better pricing.

The prospective investors, whether they be banks or foreign portfolio investors (FPI), have started seeking access to the underlying financial position of the states before they look at investing in SDLs.

The states are likely to face larger redemption pressure from 2022-23 onwards and hence will be required to be equipped for the ground realities of that period.

As per the RBI’s extant regulations, SDLs being similar to Government of India (GOI) securities, qualify for inclusion as part of level 1 High Quality Liquid Assets(HQLA) in the books of banks by virtue of an implicit sovereign guarantee and default-free status for its market borrowings.

“This may change in the future, in which case banks may have to begin assigning risk weights to SDLs and in that case, the State Governments will need to strategize for this eventuality,” said an RBI official.

Maybe due to the lakh of desired transparency on the state of affairs of the finances of the States that issue SDLs, the foreign portfolio investors (FPIs) are not upbeat about investing in SDLs.

RBI is understood to be taking steps to encourage the states to get rating for their SDLs from leading agencies. Already the Central Bank has taken steps to incentivize the states by reducing the initial margin requirement under liquidity adjustment facility (LAF) for rated SDLs.

According to experts in the field, going forward, transparency on the financial status of the states will be a determining factor while entering the debt market.

“Transparency includes having an independent audit of sub-national financial accounts, making periodic public disclosures of key fiscal data, exposing hidden liabilities, and moving off-budget liabilities on budget,” explained BP Kanungo, deputy Governor, Reserve Bank of India (RBI).

Talking to, experts in public finance flagged concerns about the innovative model Kerala has established for its infrastructure investments outside the budget (off-budget) by setting up Kerala Infrastructure Investment Fund Board (KIIFB).

This gains significance at a time when Kerala has approached the Centre for approval to borrow more in the wake of the worst floods that hit the state causing huge loss to its people and the government. Views are divided over whether Kerala should be allowed to bloat its fiscal deficit, albeit for a genuine purpose.

KIIFB’s books have not been a worrying point for the Centre as it doesn’t jump any of the signals set by the FRBM. But the moot question is whether the SDL market will view the fast growing liability side of KIIFB with a pinch of salt since it is the same government that is guaranteeing the KIIFB’s debt.

Apart from its own fund base of a little over Rs4000 crore, KIIFB has lined up funding channels in the form of masala bonds, debentures, external commercial borrowings (ECBs), term loans from banks etc, to finance a long list of infrastructure projects in Kerala. The Board is all set to raise about Rs10,000 crore through the newly established Pravasi chiti too.

The Finance Minister Dr Thomas Isaac and the KIIFB’s high profile chief executive officer (CEO) Dr KM Abraham have time and again tried to scotch the fears about the funding matrix of KIIFB.

“Government has already guaranteed a contribution of share of motor vehicle tax (MVT) and cess levied on petroleum products to KIIFB and this will, to a good extent, fend off the financial worries arising from KIIFB’s debt,” Dr Isaac had earlier clarified.

The market for state development bonds (SDLs) that predominantly support state spending has over the years grown huge and unlike before, the SDL market has assumed greater relevance today.

The market borrowings by the state governments have been fast growing in contrast to that of the Central government’s dated market borrowings.

The financing of gross fiscal deficit (GFD) through market borrowings, which constituted only a small fraction of sources of financing before 1990, has increased significantly to 74.9 per cent in 2017-18 (revised estimates).

The size of state budgets is fast growing, and while the market borrowings of states are surging in size that of the Central Government securities is shrinking.

Market share of State Development Loans (SDL) in outstanding debt has increased from 16.59 per cent in 2008-09 to 29.06 per cent in 2018-19 as against a decrease in share of Government of India (GoI) from 83.41 per cent (G-Sec & T-Bills) to 70.94 per cent during the same period.

An internal study of RBI and Centre for Advanced Financial Research and Learning (CAFRAL) had examined the impact of SDL spreads on corporate bond yields and it was observed that rise in yields on state government paper ends up pushing spreads on corporate bonds.

“SDL crowds out corporate borrowings in the bond market by increasing costs. A one percentage point increase in the ratio of state debt issuance to GDP, results in an 11 per cent decline in the volume (in rupees) of corporate bonds issued during 2016,” the study observed.



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