The Hindu Business Line : Centre's debt swap plan runs into trouble

The debt swap programme, kick-started last fiscal year, was intended for allowing State Governments to refinance their high cost Central borrowings with market borrowings and thereby reduce interest payments. Central loans to the States were priced at rates as high as 13 per cent.

On the other hand, States were in a position to raise funds at rates less than 8 per cent through market borrowings for tenures up to 10 years.

The reduction in the rates has major fiscal implications on the States, since debt servicing currently comprises almost 25-30 per cent of the revenue expenditure.

Banking sources said that few of them were interested in picking up State Government securities. State Government securities are treated as illiquid securities by banks, though they are backed by a sovereign guarantee.

With liquidity at a premium in the markets, few banks are interested in picking up illiquid securities.

Besides, the bankers said most of them were already operating at high investment-deposit (ID) ratios (investments, mostly Government securities, as a percentage of deposits).

Presently, the ID ratios of banks are about 44 per cent. The prescribed statutory liquidity ratio for the sector is 25 per cent. Consequently, the sources said, investing in State development loans at low yields made little sense when the industry was attempting to align the investment-deposit ratios as close to the prescribed SLR as possible.

Moreover, banks are also faced with a situation of rising costs of working funds. The focus therefore is on raising the yield on assets.

Since the last two years, the average yield on assets has been falling due to the high ID ratios, the sources said.

Most of the banks now preferred shifting to credit, where the returns were far higher.

Shifting to credit, the bankers said, would help them improve the average yield on assets to double digits, as against the current average of only 7.5 per cent. The changed preference was evident from the rising credit deposit ratios of the banking sector. The ratio, indicates the volume of advances as a percentage of deposits, was 61 per cent, currently the highest in two years.

Bankers also said that the lack of interest in State Government securities also stemmed from the delays in remitting interest payments by the States.

Such delays resulted in major liquidity problems for the banks. Above all in a tight market, State Government securities tend to drop in value faster than Central loans.

As a result the fear among banks was that the depreciation requirement would be higher for such securities, the sources added.