The spread between state development loan (SDL) yields and the benchmark bond yield has narrowed after the December monetary policy, indicating that SDL yields have not shot up as much as the G-Sec yields as the central bank announced the status quo.
According to the SDL auction results available on the Reserve Bank of India (RBI) website, the spread between the cut-off yields on 10-year SDLs and the benchmark yield has ranged between 53 and 58 basis points (bps) post the monetary policy announcement. However, prior to the policy, the spread stood in the range of 67-71 bps.
Vijay Sharma, senior executive vice-president at PNB Gilts, said the surge in government securities (G-Secs) yields could be attributed to the fact that traders had built in long positions in G-Secs prior to the monetary policy expecting a repo rate cut, which they offloaded after the status quo. “However, unlike G-Secs, SDLs did not see huge trading positions getting built up by traders ahead of the policy. Even over the last two months, trading positions in SDLs were not so high as the demand was investor-driven. That is why there was no sell-off in SDLs which is why their spreads over benchmark G-Sec yield have narrowed in recent times. We expect them to widen in coming weeks,” he said.
SDL yields have also gone up post the monetary policy. However, the rise has not been as much as seen in G-Sec yields. For instance, prior to the monetary policy announcement, the Rajasthan 10-year paper was auctioned at a cut-off yield of 7.18%; while the cut-off yield on the paper in the auction post the policy stood at 7.27%. Similarly, the 10-year Assam paper was auctioned at a cut-off yield of 7.18% prior to the policy, while post the announcement, the same paper was auctioned at 7.26%. This indicates a 8-9 basis points hardening.
Compared to this, the benchmark yield rose by about 25 bps since the first week of December.
Madan Sabnavis, chief economist at Care Ratings, said the narrowing of spread is more a case of G-Sec yields rising at a higher rate. “That is because there is so much uncertainty on whether the fiscal deficit can be met and whether there would be additional market borrowing. When you are talking about state governments, you know that because of the FRBM rules being fully imposed, it is not possible for them to borrow more. In case they are running into problems, they will have to cut back on expenditure.”
Sabnavis also pointed out that states cannot allow their deficits to go beyond 3.5%. “Even to go above the 3%, certain strict conditions have to be met. As of now, it seems states are not spending more. They have had issues of GST compensation which got resolved recently. To my mind, states are keeping their capital expenditure on hold so that they don’t have to borrow more money,” he said.
According to an RBI report on fiscal position of states, states have budgeted a GFD-GDP ratio of 2.6% in 2019-20, with 12 states expecting to remain above 3%. “To sum up, the GFD-GDP for states recorded improvement in 2017-18 (accounts) vis-à-vis 2016-17 and remained well within the threshold of 3% during 2018-19. A similar outcome is budgeted for 2019-20 (BE),” the report said.
The report, however, indicated that debt liabilities had been rising during 2016-19 and are likely to remain around 25% of the GDP in 2019-20, clearly making the sustainability of debt the main medium-term fiscal challenge for states.