Com­pet­i­tive fed­er­al­ism in the state bond mar­ket

The Pak Banker - - OPINION - Ira Dugal

ONE data point does not make a trend. Still, some data points are in­ter­est­ing enough to an­a­lyse and see if they rep­re­sent the start of a trend. The data point in ques­tion is this week's auc­tion of state govern­ment bonds (a.k.a. state de­vel­op­ment loans). The auc­tion, usu­ally a rou­tine af­fair which gets far less at­ten­tion than cen­tral govern­ment bond auc­tions, caught the eye of mar­ket watch­ers. There were two rea­sons for this. First, the yields be­ing de­manded by the mar­kets for state bonds jumped con­sid­er­ably. Se­cond, there was a wide dif­fer­ence be­tween the yields de­manded on bonds of dif­fer­ent states, which was un­usual. While both th­ese points were note­wor­thy, it was the se­cond that got peo­ple talk­ing.

Soumya­jit Niyogi of In­dia Rat­ings in a note high­lighted the dif­fer­ence in the yields from state to state and at­trib­uted this to "higher is­suances by a few states and pos­si­bly dif­fer­en­ti­a­tion on ac­count of credit qual­ity and liq­uid­ity is­sues". R. Si­vaku­mar, head of fixed in­come at Axis Mu­tual Fund felt that the power dis­tri­bu­tion com­pany (dis­com) re­vival scheme, which in­volves the con­ver­sion of dis­com loans into state govern­ment bonds, may be im­pact­ing the view that in­vestors are tak­ing on dif­fer­ent states. In the ab­sence of a defini­tive ex­pla­na­tion (and it may be too early for one), it may be in­ter­est­ing to work back­wards and look at the states that were asked to shell out more to bor­row.

The state that paid the high­est in­ter­est rate to bor­row at this week's auc­tion was West Ben­gal. It bor­rowed Rs.2,500 crore for a pe­riod of 10 years at 8.88%. Ut­tar Pradesh paid 8.83% and Bi­har paid 8.82% to bor­row the same amount. The state that got the best rate was Odisha, which bor­rowedRs.1,000 crore at 8.48% (but for five years). Data col­lated from a 2015 Brick­work Rat­ings re­port shows that each of the three states where yields jumped has seen a sig­nif­i­cant jump in bor­row­ings over the last five years, al­though they aren't the states that saw the big­gest jump. In the case of West Ben­gal, mar­ket bor­row­ings over the last five years be­tween fis­cal 2011 and fis­cal 2016 have jumped 328%; bor­row­ings for Ut­tar Pradesh are up 237%; and Bi­har's mar­ket bor­row­ings have jumped nearly 200%. Over­all, state govern­ment bor­row­ings are up about 90% over this pe­riod.

But just look­ing at the quan­tum of gross mar­ket bor­row­ings may not fully ex­plain the rea­son some states are be­ing pe­nalised more than oth­ers. In a pre­sen­ta­tion, Sau­gata Bhat­tacharya, chief econ­o­mist at Axis Bank, high­lighted an im­por­tant point. Data com­piled by his team shows that states at an ag­gre­gate level have frit­tered away most of the sur­plus they may have built up dur­ing the good years. This has meant that a larger pro­por­tion of the con­sol­i­dated state fis­cal deficit is be­ing fi­nanced through mar­ket bor­row­ings. So, in fis­cal 2015, 78% of the 2.3% state fis­cal deficit was fi­nanced through mar­ket loans com­pared to 71% of the 2.5% deficit in fis­cal 2014.

Some states are more re­liant on bor­row­ings that oth­ers. West Ben­gal, for in­stance, saw it net mar­ket bor­row­ings surge to 142% of its 201415 fis­cal deficit from 89% of its fis­cal 2014 deficit, showed Bhat­tacharya's pre­sen­ta­tion. This is the worst among ma­jor states in this re­spect and also one of the big­gest bor­row­ers in ab­so­lute terms. That may ex­plain why it paid the high­est in­ter­est rate at the auc­tion. An­other fac­tor that is get­ting tacked on while as­sess­ing the credit qual­ity of states is the dis­com re­vival pack­age. For in­stance, Ut­tar Pradesh has agreed to take over near­lyRs.40,000 of the debt of its power dis­tri­bu­tion util­i­ties and con­vert this amount into state govern­ment bonds.

Just like West Ben­gal, the state is al­ready a heavy bor­rower and as per fis­cal 2016 bud­get es­ti­mates, Ut­tar Pradesh's mar­ket bor­row­ing were pegged at just un­der Rs.46,000 crore. For Bi­har, the jump in in­ter­est rates may be emerg­ing from the fact that its ab­so­lute mar­ket bor­row­ings have in­creased and its net mar­ket bor­row­ings as a per­cent­age of fis­cal deficit has gone up sharply from 32% in fis­cal 2014 to 72% in fis­cal 2015. At about Rs.2,300 crore, its bur­den from the dis­com re­vival pack­age is lower .

It's im­por­tant to note that the dis­com scheme doesn't ap­pear to be the only thing the mar­ket is fo­cus­ing on. Ra­jasthan, which will take over the max­i­mum (Rs.60,000 crore) in dis­com loans, man­aged to bor­row at a rel­a­tively lower 8.65%. This may be be­cause it is cur­rently fi­nanc­ing a lower pro­por­tion of deficit through bor­row­ings. To sum up, mar­kets are start­ing to dif­fer­en­ti­ate be­tween states based on their in­di­vid­ual credit qual­ity. If this trend per­sists, states will be un­der greater pres­sure to man­age their fi­nances bet­ter. The dif­fer­en­ti­a­tion is hap­pen­ing on the ba­sis of a state's track record and in an­tic­i­pa­tion of any fu­ture bur­den it may have to in­cur on ac­count of li­a­bil­i­ties such as dis­com debt and the im­pact of the 7th Pay Com­mis­sion.

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