States to borrow more, at higher cost

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Published: April 13, 2020 4:15:59 AM

Due to cash shortages, many states including Maharashtra, Telangana and Odisha are being forced to cut expenditure and defer some others, including salary payments.

As many as nine states raised 10-year bonds at yields between 7.80% and 8% on April 7.

State governments could become a lot more indebted in FY21 as they borrow at a faster rate than the Centre, marring their recent track-record of being less profligate. Several states are now asking for FRBM forbearance, allowing them to raise the deficit level to as much as 5%. The combined fiscal deficit of states in FY20 is estimated to have been higher than 2.6% of the GDP. Some are not only scaling up their borrowings but are also seriously front-loading them, as the Covid-19 pandemic compels them to step up healthcare, welfare and development expenditure, at a time when their revenue flows are drying up.

Hard-pressed, some states are even disregarding the exorbitant costs such fund-raising entails, in a clearly risk-averse, jittery market. While the announced indicative schedule for SDLs in the April-December FY21 and April-June periods suggest a front-loading bias, actual auctions could prove to be even more frequent and adventurous.

While the RBI’s indicative calendar puts the ceiling for market borrowings by the state governments in Q1FY21 (April-June) at Rs 1.27 lakh crore, 56% higher than the SDLs raised by them in the year-ago quarter, on April 7, in the first instance of SDL auction in the new fiscal year, 19 states among them raised a total amount of Rs 32,560 crore, against Rs 37,500 crore sought by them. In fact, bonds sold by these states on that day were 44% higher than the indicative total in the RBI calendar.

As many as nine states raised 10-year bonds at yields between 7.80% and 8% on April 7. For these securities, investors sought a spread of 140-160 basis points above the central government bond yield of 6.4% for the same tenure. This was much higher than the 115-bps spread in the March 30 auctions. Kerala, which offered 15-year securities to raise Rs 1,930 crore, would pay as much as 8.96%, the highest rate by any state.

Haryana raised 96% of its Q1FY21 quota of Rs 5,200 crore on April 7, Kerala utilised 91% of its Q1 quota of Rs 6,500 crore and Maharashtra 29% of its share of Rs 17,500 crore. Thanks to the exorbitant interest rates, Andhra Pradesh did not accept any amount in the 13-14-year maturity bucket and Punjab refrained from issuing 10-year securities. Gujarat and Rajasthan accepted only partial amount and Himachal Pradesh opted out.

Kerala finance minister Thomas Isaac told FE that with the state’s increased expenditure commitment s for distress relief, settlement of arrears and even certain capital spending plans which too are not really amenable to adjustments, the state would have no option, other than front-loading the SDL auctions. He said that the interest rate for its 15-year bonds went up so much because, banks, despite being flush with funds, were showing a sticky ‘liquidity preference.’ He alleged that banks were reluctant to lend to states, even amidst scarce private demand for capital (corporate bond issues).

Isaac said that given the possibility of heightened borrowings by the Centre and states in a shorter duration of time under the current circumstances, the Centre should urge the RBI to buy its securities and monetise its deficit. Or else, the Centre, the Kerala finance minister warned, would be pushing many states into a debt trap. (On its part, the central government is slated to raise 62.5% of its budgeted full-year gross market borrowing target, or Rs 4.88 lakh crore, in the first half of this fiscal).

Market analysts reckon that the states and the Centre would go for very substantial extra borrowings over and above their budget estimates, a possibility which is getting priced in the bond auctions already. A Prasanna, chief economist at ICICI Securities PD said: “After the policy rates (were cut by 185 bps since January 2019 by the RBI) and overnight rates have come down so much, if still the bond yields (as seen in SDL on April 7) are so high, that shows that market is worried and transmission is broken”.

General risk aversion among investors, including banks, in times of heightened uncertainties and fears that both the centre and states will be forced to borrow in large amount despite worsening macro fundamentals have caused bond yields to surge. This is despite the fact that the central bank has trimmed key policy rates drastically and shored up liquidity in the system. The excess liquidity was to the tune of Rs 2.5 lakh crore in the week through March 27, according to CARE Ratings. States like Kerala, with perceived populist stance, are forced to pay even higher yield.
On March 31, RBI pegged the total market borrowing of 23 states/UTs in Q1FY21 at Rs 1.27 lakh crore, which was a steep 56% higher than the actual SDL issuance of Rs 81,500 crore in Q1FY20.

The actual borrowing in Q1 may turn out to be even higher than indicated by the RBI going by the first auction and the higher needs of the states. The Union finance ministry letter dated March 23 to the RBI ahead of announcement of the borrowing calendar that states be allowed to borrow up to 50% of the net borrowing requirement in FY21 in the first nine months of the fiscal, giving option to states to borrow more than the Q1FY21 indicative amount notified by the RBI. While the net borrowing limit for states is set at Rs 3.2 lakh crore by the finance ministry, the gross borrowing would be about 30% higher or at about Rs 4 lakh crore during the period.

Rating agency ICRA has estimated a 25%-30% increase in net SDL issuance to Rs. 6.2-6.4 lakh crore in FY21 from the level of Rs 5 lakh crore in FY20. It has estimated gross SDL issuance to rise by nearly 19%-23% to Rs 7.6-7.8 lakh crore in FY2021, from Rs. 6.3 lakh crore in FY20.

The states’ finances had bucked trend and deteriorated from last year. They must have suffered fiscal slippage in FY20 itself: tax revenue growth of 20 states reviewed by FE was less than 1% in the first nine months of FY20, compared with 15% in the year-ago period. As a result, these states had borrowed 24% more in April-December of FY20 than in the year-ago period. With shortfall in states’ GST revenue, unpaid GST compensation due to the inadequacy of the relevant cess proceeds, a big overall reduction in tax devolution and ‘own tax receipts, the fiscal slippage is going to be even steeper in FY21.

Some state chief ministers have recently requested prime minister Narendra Modi to raise FRBM mandated fiscal deficit from 3% of GSDP to 5% for FY21. As per state budgets, their combined fiscal deficit stood at 2.4% of GDP in FY19 and the target (BE) for FY20 was 2.6% (actuals to be higher).

Maharashtra was expecting tax revenue of Rs 20,000 crore (Rs 15,000 crore own revenue and Rs 5,000 crore central transfers) in April. “Now, we are pegging revenues to be only around Rs 5,000 crore in the month,” said the state’s finance secretary (expenditure) Rajiv Kumar Mittal.

Due to cash shortages, many states including Maharashtra, Telangana and Odisha are being forced to cut expenditure and defer some others, including salary payments. “Even after the lock-down is lifted, the normal economy activity could remain highly suppressed for a few months,” Mittal said.

Odisha,a revenue-surplus state, can manage for a couple of months without front-loading market borrowings. “Thereafter, the state’s finances will become shaky if tax revenues do not pick up. We will have to raise more money from the market,” said Odisha finance secretary Ashok K.K Meena.

Jayanta Roy, Group Head – Corporate Sector Rating, ICRA Ltd, said: “…the risk of fiscal slippage is expected to be higher for states, which have a larger number of Covid-19 patients, as they may have to significantly ramp up spending on health-related services to contain this outbreak. Moreover, states which have witnessed the return of a considerable number of migrant labourers, and which have a sizeable number of daily wage earners, could see a sharp rise in their revenue expenditure in FY2021, if they choose to extend food and/or income support to such people”.

The NK Singh panel on fiscal responsibility had suggested overall public debt-to-GDP ratio of 60% by 2022-23—40% for the central government and 20% for states. The outstanding debt of the states has risen over the last five years to an estimated 25% of the GDP in FY20 (actual could be higher), posing medium-term challenges to their debt sustainability. Among major states, Punjab has the highest ratio at around 40% for past four years. The Centre’s debt-to-GDP was estimated to be around 49% of GDP (revised estimate) in FY20, up from 48.7% in FY19 and the ratio would likely be much worse in FY21.

(With inputs from Banikinkar Pattanayak)

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