The new normal for state borrowings

Have the states shown a lack of prudence in their borrowing programme to tide over the pandemic?

Normally, the Union and state governments tend to reveal a skewed pattern in their market borrowing. While the Centre’s borrowing is typically front-loaded during the first half of the financial year, for the states, market borrowings tend to be much more during the second half. This year is, however, an exception.

Twenty seven states have already borrowed almost ~1 trillion during March 17 to June 30. Interestingly, this is close to the shortfall in goods and services tax (GST) collections of the country in the months of April and May 2020. Since the promulgation of GST, state revenue depends majorly on GST collections. The other three sources are sales tax/value added tax on petroleum products, excise duty on alcohol, and motor vehicle tax. Due to the lockdown, consumption of diesel has fallen by 42 per cent in the first two months of FY21. Automobile sales have reached their nadir and excise collection on sale of alcohol has just started looking up. At the same time, Covid-19-related expenditure have dried up the coffers of most states. Therefore, the only way the states can meet the liquidity shortfall is through market borrowing. Thus, the question arises: Is it the Covid-19 pandemic that has made the states to front-load their borrowing programme?

The data on state borrowings indicate that the reality could be more nuanced and reveal a number of interesting but distinct trends (see table).

First, contrary to the expectation that states with higher number of Covid-19 positive cases would borrow more, the correlation between the number of Covid-19 cases and borrowing turns out to be moderate and close to 45 per cent. However, there are two outliers in the data: (a) the largest borrower, Uttar Pradesh, does not have the highest number of Covid-19 cases; and (b) Maharashtra, with the highest number of Covid-19 cases, borrowed only half the amount borrowed by Uttar Pradesh. In fact, if we get rid of these two outliers, then the correlation between the number of Covid-19 cases and the amount of borrowing jumps to 72 per cent.

Second, a few states were in a hurry to raise funds the moment the lockdown was announced. For example, Uttar Pradesh made almost 96 per cent of the borrowings in March itself. Similarly, West Bengal raised ~9,000 crore in March — 100 per cent of its borrowings during this period. These states had to pay a price for immediacy. The average yield of borrowing by these two states is 100 basis points higher than the borrowing yield of Tamil Nadu. This could be indicative of poor market timing and a lack of strategy in market borrowing on the part of some of the states.

Third, while some states were very innovative in borrowing at the long end of the yield curve, most of the states borrowed at the medium end. For example, in June, Tamil Nadu and Rajasthan borrowed ~2,000 crore and ~500 crore, respectively with 30year bonds at an average annual yield of 6.7 per cent, which is just 14-15 basis points higher than the 30year Government of India bond yield.

The trajectory of Covid-19 in India is marked by some degree of uncertainty. In fact, India is adding about 100,000 Covid-19 positive cases in less than a week. Therefore, the states with higher patient count would continue to spend its already-dwindling revenue on health care. There is another factor that puts pressure on state coffers — the cost of migrant labour. Uttar Pradesh, with the highest number of returning migrants, is expected to face sustained increase in expenditure to feed the jobless returnees. West Bengal, too, faces a similar scenario. While the states struggle to manage mounting expenditure, the prospect of revenue generation remains less than bright. In a situation when citizens are avoiding spending on non-essential goods and services, any increase in state revenue from GST (SGST) is remote in near future. Thus, as the dependence of states on market borrowing is going to continue for some more time, it is important that the states time the market well while borrowing to minimise the borrowing costs.

However, underneath these current trends of the state government borrowing, are some deeper issues. One, state government securities market lacks the dynamism of the central government securities. State government securities are primarily held by provident funds and insurance companies and since these securities lack an active secondary market, their stocks are mostly held to maturity. Open market operation with these securities are also nonexistent. Moreover, states are seldom distinguished on the basis of their fiscal conditions and associated credit ratings. The chairman of the Fifteenth Finance Commission, in a recent statement, pointed out that returning to a sustainable debt trajectory could be challenging in the medium term with both the Centre and the states substantially increasing their borrowing limits in the face of the Covid-19 pandemic. Thus, it is all the more necessary to be prudent and innovative in government borrowing programmes.