Though a total of six states with combined state electricity board (SEB) loans of Rs 139,715 crore have already come on board the UDAY restructuring programme — of the loans...
Though a total of six states with combined state electricity board (SEB) loans of Rs 139,715 crore have already come on board the UDAY restructuring programme — of the loans, half have to be replaced by state government bonds in the first year and 25% the next year — the sharp hike in state government bond yields makes these bonds that much more unattractive. This is critical to the success of UDAY bonds since, apart from banks who hold SEB debt, Life Insurance Corporation of India (LIC) and Employees’ Provident Fund Organisation (EPFO) are believed to have been sounded out to buy the bonds.
Thanks to an inexplicable surge in the bonds issued by state governments, the coupon rates have shot up. The mop-up of Rs 310,000 crore in FY16 represents a record hike of Rs 70,000 crore this year and, as a proportion of central government paper, net state government bonds have increased from around 30% in FY12 to over 60% in FY16.
As a result, Rajasthan — its SEB owes banks Rs 80,500 crore — raised its Rs 800 crore at an 8.65% coupon on Tuesday; Uttar Pradesh that has the next highest SEB exposure of Rs 53,200 crore raised Rs 2,500 crore at an 8.83% coupon. A total of 21 states raised R21,445 crore on Tuesday.
So here’s the catch: The UDAY scheme envisages a maximum coupon of the 10-year G-Sec rate plus another 75 basis points to take into account the fact that the bond is a state government one and does not have SLR status. Given Wednesday’s closing G-Sec yield of 7.83%, this means the maximum coupon for an UDAY bond can be 8.58% (based on Wednesday’s closing G-Sec yield). Yet even the state government bonds have had to pay higher rates despite their SLR status.
This poses a problem in that new potential buyers like LIC and EPFO will be hard-pressed to justify to their investment boards accepting a lower-yielding UDAY bond that does not even have SLR status.
To the extent public sector banks are forced to swap some part of their loan with the UDAY bonds, this means a double whammy. In the first instance, banks that have lent to SEBs at 10-11% rates will have to substitute them for 8.58% coupon UDAY paper. The fact that the UDAY bonds have zero risk weight will soften the blow a bit since the 5% provisioning required on the restructured SEB loans will no longer be required, and will save banks around Rs 3,500 crore for the UDAY bonds of around R70,000 crore that have to be issued by the states that have signed up so far.
Second, if banks want to trade the UDAY bonds, they will have to sell them at a discount since state government bonds that have SLR status are offering a higher coupon.