Are reg­u­la­tors be­hind the curve? TESSELLATUM

Business Standard - - OPINION - NEELKANTH MISHRA

Are reg­u­la­tors be­hind the curve on state gov­ern­ments’ bond is­suances? In the past seven years, even as the ab­so­lute fis­cal deficit of the Union govern­ment has been largely un­changed, that of the state gov­ern­ments has in­creased two-and-a-half times. As a re­sult, whereas they bor­rowed only about a third as much as the cen­tre from the bond mar­ket just six years ago, in the year that just ended they bor­rowed 76 per cent as much. Th­ese num­bers are af­ter ad­just­ing for the dis­tor­tion in­tro­duced by UDAY, a scheme that al­lowed for re­fi­nanc­ing of state dis­tri­bu­tion com­pany debts through state govern­ment bonds: More than ~2 lakh crore of bonds were is­sued un­der it in the past two years.

If we group claimants on fi­nan­cial sav­ings in the In­dian econ­omy into three groups: Bor­row­ers from banks and non-bank­ing fi­nance com­pa­nies (NBFCs), the Union govern­ment, and the state gov­ern­ments, the state gov­ern­ments seem to be the fastest grow­ing group, hav­ing reached 27 per cent of to­tal bor­row­ings in the last fis­cal year. Their scope to bor­row and spend more keeps ris­ing, as the fis­cal deficit cap is de­fined at 3 per cent of GDP, and nom­i­nal GDP con­tin­ues to grow in dou­ble dig­its. Th­ese is­suances should there­fore con­tinue to rise.

And yet, they are the least un­der­stood. Their growth has al­ready been caus­ing un­cer­tainty and tur­bu­lence in the bond mar­kets and there need to be corrections made on sev­eral fronts.

The first is the sea­son­al­ity of bor­row­ing. The Union govern­ment front-loads its bor­row­ing, with about 60 per cent of the bonds is­sued in the first half and 40 per cent in the second half of the fi­nan­cial year. This is done most likely to coun­ter­act the nat­u­ral sea­son­al­ity of credit off­take in In­dia: About 73 per cent of the pri­vate credit is is­sued in the second half. Thus, the de­mand on fi­nan­cial sav­ings gets evenly spaced through­out the year. How­ever, state gov­ern­ments con­tinue to have a second-half skewed bor­row­ing cal­en­dar (40 per cent in the first half, and 60 per cent in the second): While this did not hurt much when their ag­gre­gate bor­row­ing was small, it is now driv­ing a con­ges­tion in the fi­nal quar­ter of the fi­nan­cial year.

The second is timely avail­abil­ity and qual­ity of data. All state gov­ern­ments have pre­sented their bud­gets for this year, but there is no easy ag­gre­gate avail­able yet of how much they are go­ing to bor­row this year. The Re­serve Bank of In­dia’s (RBI’s) com­pen­dium of state bud­gets is pub­lished with nearly a year’s lag (we do not have the com­pen­dium even for the year that ended!), by which time the in­for­ma­tion is not as use­ful for the bond mar­ket. Even ac­cess­ing state govern­ment bud­get doc­u­ments on­line is trou­ble­some. The mar­ket only comes to know the to­tal bor­row­ing re­quire­ment of state gov­ern­ments when the RBI pub­lishes ap­proved bor­row­ing lim­its for the fi­nal quar­ter in De­cem­ber.

The third is a dif­fer­en­ti­a­tion in yields of var­i­ous state govern­ment bonds. The think­ing be­hind state gov­ern­ments bor­row­ing di­rectly from the mar­kets un­doubt­edly in­volved the mar­kets im­pos­ing fis­cal dis­ci­pline. How­ever, the bond yields of states with low debt to GDP like Chhattisgarh and Odisha are no dif­fer­ent from those of states with high debt to GDP like West Ben­gal and Pun­jab.

This has been at­trib­uted to a range of fac­tors: That the mar­ket as­sumes a sov­er­eign guar­an­tee (that is any state govern­ment would never de­fault ir­re­spec­tive of its fis­cal health, as the Union govern­ment would come to its help); that bond-hold­ers ef­fec­tively have first ac­cess to state govern­ment rev­enues, as the RBI, which co­or­di­nates the auc­tions, has ac­cess to state rev­enues in es­crow; state gov­ern­ments must re­quest the Union govern­ment for ex­tra bor­row­ing be­yond the pre­scribed fis­cal deficit limit, which re­duces de­fault prob­a­bil­ity sig­nif­i­cantly; manda­tory buy­ing by fi­nan­cial in­sti­tu­tions like banks gen­er­ates suf­fi­cient de­mand; and lastly that th­ese were too small for the mar­ket to worry about dif­fer­en­ti­a­tion. Some of th­ese be­liefs/as­sump­tions are in­cor­rect, but have not been tested yet.

While ad­dress­ing the first two in­volves pro­ce­dure and should be eas­ier to ad­dress, the third, that is the lack of yield dif­fer­en­ti­a­tion, is a whole lot trick­ier. At the same time, it is very im­por­tant. The Union govern­ment can only en­force fis­cal deficit tar­gets for states as long as states owe it money. By the mid­dle of the next decade, some of the states would have al­ready re­paid their dues to the Union, and the Union would lose that abil­ity.

On a sep­a­rate note: Through their grow­ing deficits are the states not un­do­ing the Union govern­ment’s fis­cal dis­ci­pline? That has in­deed been the case in past years, but Credit Suisse ag­gre­ga­tion of bud­get data of top bor­row­ers among state gov­ern­ments sug­gests that the growth in state govern­ment bor­row­ings is likely to slow to 16 per cent this year, against 28 per cent in the year that just ended, in­di­cat­ing a ta­per­ing of state govern­ment fis­cal deficits, though the start of GST this year adds some un­cer­tainty.

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