Increased supply of state development loans may put pressure on states’ borrowing costs

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Published: April 3, 2020 12:40:05 AM

As per the indicative calendar for the Q1FY21, state governments are likely to borrow Rs 1.27 lakh crore from the markets.

SDL yields did see some softening with yields on the 10-year paper falling to about 7.30-7.35% levels.

Even as the market is anticipating additional borrowing by the Centre in FY21 in the backdrop of the Covid-19 crisis, a rise in the supply of state development loans (SDLs) is likely to put pressure on the cost of state government borrowing costs, experts say.

As per the indicative calendar for the Q1FY21, state governments are likely to borrow Rs 1.27 lakh crore from the markets. In Q1FY20, they were expected to borrow Rs 1.10 lakh crore from the markets as per the indicative calendar while they ended up borrowing Rs 81,523 crore till June 28, 2019, on a gross basis, according to the RBI.

Siddharth Shah, head of treasury, STCI Primary Dealer, believes that the states’ borrowing is on the higher side as per the indicative calendar for Q1FY21 and this is going to put some pressure on the yields. “We also have to consider the lockdown conditions at present and the fact that there are a couple of scheduled holidays as well. The G-sec borrowing is also anticipated to be higher this year. Whether the RBI will step in or not is something that we will have to watch out for. While the rate cut has given some short-term relief, the huge supply of SDLs may lead to some hardening of yields,” Shah said.

With the RBI reducing the policy repo rate by 75 basis points to 4.40% last Friday, SDL yields did see some softening with yields on the 10-year paper falling to about 7.30-7.35% levels. Experts point out that although SDLs have some advantage like the preference shown by long-term investors due to the relatively higher yields and safety compared to other instruments that provide such higher returns, over-supply and persisting risk-off sentiment can hurt the yields in coming times.

Ananth Narayan, professor-finance, SPJIMR, said the borrowing numbers this year will be far higher than FY20. “I wouldn’t go by the borrowing calendar, both for the Centre and states. Borrowing for all entities, be it the Centre, state governments or public sector enterprises, are going to go up. There is no other choice under the current circumstances. Nobody can peg the figures at the moment. They would have to make some changes to the FRBM that limits the states’ fiscal deficit from going beyond a certain point. Also, at some stage, the RBI will have to come in and start doing OMO purchases to fund the rising deficit. We have very little choice here,” Narayan said.

Another question that market participants raise is about the investment appetite of banks for SDLs. Manish Wadhawan, managing partner at Serenity Macro Partners, said the risk appetite of the banking system is very low at the moment as they fear that their deposits are taking a hit in recent times while they are also holding excess SLR instruments.

“The markets fear that the fiscal deficit might be far higher than budgeted and the supply of G-secs and SDLs will also be huge this time. FPIs have sold a significant amount of bonds in the month of March while the absorption capacity of domestic markets is not so strong. The lockdown is also hurting the markets. SDL yields will remain high in coming times,” he said.

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