Bond yields rose on change in state fund transfer dates
Sudden surge in supply of state paper caused turmoil in market, catching observers off guard
From April 2018, the Centre began transferring states’ share in direct taxes on a quarterly basis. The change created a cash management problem for states. To meet cash need, states had planned to borrow more in the first half of the fiscal year from markets. This surge in the supply of state paper caused a turmoil in the bond markets in early April. Yields soared, catching observers off guard. ISHAN BAKSHI writes
Last year the Union Finance Ministry changed the dates on which it periodically transfers to states their share in central taxes.
The conventional practice was to transfer funds on a monthly basis. Instead, the Centre had decided, it would from April 2018 (when the new financial year began) be transferring the states’ share in direct taxes on a quarterly basis.
Transfers from Centre are a significant proportion of state revenue. So, the change created a cash management problem for states - they would have to find their own resources for spending, till the central transfer at the end of each quarter.
To meet this need for additional cash every quarter, states had planned to borrow more in the first half of the financial year from markets. This surge in the supply of state paper caused a turmoil in the bond markets in early April. Yields soared, catching market observers off-guard.
Perhaps realising the cascading effect of its decision, the finance ministry has now backtracked somewhat. It has reverted to transferring some funds to states on a monthly basis.
The change
Till these changes were put in place, the finance ministry typically sent to states their share in central taxes in 14 installments over the year. From April to January, the Centre transferred a 14th part of a state’s budgeted share for the year. It would then transfer one tranche in February and another three in March (last month of the financial year), based on the revised estimates (RE) of revenue collection.
This arrangement, the finance ministry decided last year, would change from 2018-19. States’ share in direct taxes (both income and corporation taxes) would be devolved each quarter – June 15, September 15, December 15 and March 15. These quarterly releases would be equal to a fourth of the budget estimates till the third quarter of the financial year. The remaining share would be released during March, based on the RE for the financial year.
For revenue from basic customs duty and excise duty outside the ambit of the goods and services tax (GST), the transfers to states would be on the 15th of every month. These would be made in 11 monthly installments, amounting to a 14th each of the budget share from April to February. The balance would be devolved in three equal installments in March, in line with the RE. States’ share in Central GST would be transferred on the 20th of every month.
The proposal to change the manner in which funds are transferred from the Centre to states was mooted by the expenditure management commission, confirmed multiple sources.
From the Centre’s point of view, these were prudent changes. Taxes typically get collected in a staggered manner. So, to pay states on a monthly basis, it had to routinely borrow from markets. These changes could also lower its interest burden.
Theeffect
To put the change in dates in perspective, consider that the total share of all states in income and corporation taxes is pegged at ~4.17 trillion for 2018-19. In the old scheme, states would have received ~298 billion at the beginning of each month. But, with the Centre deciding to release this only in mid-June, states would have faced a collective crunch of a little over ~600 billion over two and a half months.
Facing this additional gap, states were forced to plan to borrow a much higher sum right at the beginning of the year. This higher and unexpected supply of bonds in April, quite naturally, led to a surge in yields.
“Some states had raised this issue at a pre-Budget meeting with the Union finance minister. The Centre did not reconsider it at that time. While total borrowings of the states might not change, the borrowing would have to be frontloaded,” said Sushil Modi, deputy chief minister and finance minister of Bihar.
There is evidence of this. Reserve Bank of India (RBI) releases an indicative calendar of how much the states intend to borrow in each quarter of the year. This change shows up in the states indicative borrowing calendar. The calendar showed that states planned to borrow almost twice the amount in the first quarter of 2018-19 as compared to the same period last year. The indicative borrowings were pegged at ~1.15-1.28 trillion in the first quarter (Q1) of FY19. By comparison, states had borrowed only ~650 billion in Q1 of FY18.
Typically, the Centre front-loads its market borrowing, while states do the bulk of theirs’ in the second half the year. This time, the opposite happened. The states front-loaded their borrowings; the Centre back-loaded its own.
“This surge (in state borrowings) is likely to beacon sequence of the change in the states’ assessment of their cash flows after the modification in the timing of d evolution of central taxes, which typically used to follow a rather steady pattern in the first three quarters of each fiscal year until FY18,” said Aditi Nayar, principal economist at ratings agency Icra.
Perhaps, as a result to the turmoil that ensued in the bond markets, the Centre has now backtracked from its decision to transfer funds to states on a quarterly basis.