State borrowing: RBI DG BP Kanungo flags risks

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Mumbai | Published: September 1, 2018 3:15:41 AM

Increased market borrowing by states is partly responsible for the hardening in sovereign yields and may also be feeding into inflation, a top Reserve Bank of India (RBI) official said on Friday.

State borrowing: Top RBI official flags risks

Increased market borrowing by states is partly responsible for the hardening in sovereign yields and may also be feeding into inflation, a top Reserve Bank of India (RBI) official said on Friday.

BP Kanungo, deputy governor, RBI, said, “The increased reliance of the Centre and states on market borrowings has led to an oversupply of government papers in the g-sec market and contributed to the hardening

of sovereign yields. This results in a spiral, whereby increased market borrowing result in increased redemption pressure, which induces further borrowing to service outstanding debt and accumulated interest.” He was speaking at an event organised by the Bengal Chamber of Commerce and Industry.

The oversupply of state paper and the consequent hardening of the yield has a cascading effect on the interest rate in other segments of the financial market and even feeds into inflation through input cost. As a result, higher yield levels end up creating a vicious cycle, Kanungo noted.

Kanungo said that there is also an impact on the corporate bond market. An internal study by the RBI and Centre for Advanced Financial Research and Learning to examine the impact of state development loan (SDL) spreads on corporate bonds has found that a rise in yields on state government paper ends up pushing the spread on corporate bonds. “Unlike central government debt which crowds out bank credit, SDLs crowd out corporate borrowing in the bond market by increasing cost,” Kanungo said. “High-rated corporate bonds and those with longer maturity have a higher propensity of being crowded out by SDLs.”

He also flagged low appetite for state government securities among foreign portfolio investors, who have often cited lack of information, the financial position of states between two budgets and the opacity of state governments’ operations as reasons for the same. To correct this, states need to reach out to investors by introducing greater transparency to their functioning and placing high-frequency date on state finances in the public domain.

Kanungo observed that states’ demand for greater avenues to invest their surplus cash balances was justified. Cash-surplus state governments should consider lending to those running a deficit at an interest rates linked to the market. “Of course, this needs to be budgeted,” he added.

In addition, the creation of an index measuring debt sustainability and fiscal prudence performance indicators could be attempted to measure state governments’ fiscal performance. Fiscally strong governments can take the initiative to get themselves rated on such parameters from standalone rating agencies. This may help them get better rates at auctions of their bonds, Kanungo said.

While the Centre’s net borrowing seems to be static in the past couple of years at about Rs 4 lakh crore per year, the overall public sector borrowing requirement by the Centre, state governments and their entities are seeing a big jump. The combined market borrowings of states are projected to rise from Rs 3.5 lakh crore in FY17 (66% of the combined fiscal deficit of states) to Rs 4.4 lakh crore (91%) in FY19, as they virtually stopped accessing costly National Small Savings Fund (NSSF). Additionally, the Centre has lined up plans to raise a massive Rs 1.7 lakh crore via the extra-budgetary resources (EBR) route in the current fiscal, up 110% from FY18. The EBRs, all of which will have to be serviced out of the Budget, will be mobilised through assorted public-sector entities, crowding out the private sector from the market and putting pressure on bond yields.

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