There has been a steady and durable build-up of surplus cash balances of state governments in the last four financial years. The state government cash surpluses are automatically invested in the 14-day Intermediate Treasury Bills (ITBs). State governments also invest in the 91-day, 182-day and 364-day Treasury Bills of the Government of India (GOI) through the non-competitive bidding route, outside of the GOI Treasury Bill Auction Calendar (Auction Treasury Bills or ATBs). The adjacent table shows that the average cash holding invested in GOI Treasury Bills has gone up substantially from around Rs 17,000 crore in April 2005 to over Rs 1 lakh crore in March 2009.
Investments in 14-day ITBs yield 5% return for the states. However, these bills can also be rediscounted by the states at a penalty of 0.5%. In contrast, investments in ATBs are at the weighted average price of the competitive segment, which is market determined. While the return on 14-day ITBs has continued to remain at 5% throughout the above period, the range of yields on ATBs has significantly varied. The yields declined from 7.3-7.5% in March 2008 to 4.8-5.3% in March 2009 and further to 3.2-3.8% in July 2009. Yields on ATBs ranged between 3.2-4.6% in September 2009. Hence, 14-day ITBs give both higher flexibility and higher returns to the state governments compared to ATBs in the current interest rate regime.
Regarding the source of this cash build-up, earlier it used to be autonomous, contributed primarily by the excessive inflows through deposits under small savings schemes. In 2005-06, 82% of the Gross Fiscal Deficit of the States (GFSD) was met through small savings deposits, and market borrowings financed only 17% of the GFSD. However, there has been a sharp compositional shift in the financing pattern of the GFSD since then. Small savings deposits were budgeted to meet only 20% whereas market borrowings were budgeted to contribute 57% of GFSD in 2008-09. Thus, the autonomous cash inflows of the state governments have given way to planned cash inflows in recent years. But notwithstanding this compositional shift, the phenomenon of cash build-up has continued. Thus it seems that the states are now, as a matter of fiscal policy, deliberately seeking to build-up their cash surpluses!
This also means that the states are willing to foot the associated holding cost. While the states pay interest on their market borrowings (in 2008-09, the weighted average yield of state government market borrowings was 7.87%), they also earn a return on their investment of cash surpluses with GOI. Though the states have tried to improve their returns from investments in GOI TBs in the current regime, by substantially shifting from ATBs to 14-day ITBs, their investments still earn them only below 5% interest. The interest difference of about Rs 2,000 crore, estimated on the basis of the average investment of Rs 82,934 crore in 2008-09, is still being borne by the state governments. On the other hand, this investment by the states works to the advantage of GOI as it gets cash to meet its expenditure requirements at the corresponding cost, though along with the associated volatility.
What all could be the reasons for states building up such large cash positions inspite of the associated cash holding cost? First, several state governments are yet to implement the Sixth Pay Commission Award which could quickly deplete their cash position. Secondly, the borrowing limits allocated by the Centre cannot be rolled over into the next financial year. So it may be seen as being more prudent to mop up as much borrowing as possible within the limit allowed rather than to risk being short of cash later on. Thirdly, the cash inflows both from taxes and market borrowings are back-loaded.
It is natural that, with 80% of the market borrowings of the states being in the second half of the financial year, the state governments hold large cash balances at the end of the financial year. It may be useful if the states improve their cash management and spread out their borrowing calendar over a longer period of time in tune with their cash requirements.
Large mop-up and holding of cash balances by Central and state governments can substantially impact liquidity in the financial system and thereby impact monetary policy. In fact, mop-up of cash by the Central and state governments may provide a soft exit to the Reserve Bank of India, which is reportedly looking for an exit option from the accommodative monetary policy which had to lead to a glut in liquidity.
?V Sivasubramanian is a civil servant. His coauthor, Dakshita Das, is also a civil servant.Views expressed here are personal