The Hindu Business Line : Borrowing costs of States to soar on repo rate hike

Bangalore, June 25 Market borrowing costs of States are expected to sharply escalate after the 50 basis points hike in the Reserve Bank of India’s repurchase rates.

Among the first that are likely to face the impact of the repo rate (RBI’s liquidity support mechanism against collateral of Government securities) hike are — Andhra Pradesh, Uttar Pradesh and West Bengal. These three States are raising Rs 2,300 crore on June 27 through issue of state development loans (SDL). SDLs are sovereign guaranteed borrowings by the State Governments and have a 10-year maturity profile.

The ascent in costs was evident from the secondary market transactions in SDLs. The 8.52 per cent 2018 West Bengal SDL was traded at 9.08 per cent, or 50 basis points over the 10-year sovereign yield of 8.58 per cent. But bankers said that the new issues are likely to see even higher yields. In fact, expectations are that the yields are likely to come closer to the levels that prevailed in 2001-02. The weighted average yield of SDLs was 9.2 per cent in 2001-02.

The upward pressure on yields was also in view of the low interest in SDLs. The low interest was largely due to preference for short maturity securities that generated better yields. Besides, bankers said, that the preference was more in favour of Treasury Bills that are treated as far more liquid instruments than SDLs. The 91-day T-bills currently generate yields of about 8.73 per cent. The disinterest in SDLs was also due to banks’ high investment-deposit ratio of 32 per cent. This was far in excess of the mandated statutory liquidity ratio of 25 per cent.

Bankers also said the large deposit accretions, within the banking system, were mostly short dated time deposits of about six months. The deposits were mostly from corporates that had drawn down their sanctioned limits and parked the funds in short-term time deposits as a hedge against firm interest rates.

In addition, most of the public sector banks had already completed their churning of investment portfolios, to take advantage of the RBI’s one-time allowance. The RBI guidelines permit a transfer of marked to market category of securities to the Held to Maturity category up to 25 per cent of the banks’ demand liabilities once every year. Therefore, fresh purchases of SDLs would have to be marked to market. This implied that SDLs carry the implicit risk of depreciation in the coming weeks, as the battle to contain inflation intensifies.

As a result, only institutions like the Life Insurance Corporation of India, whose liability profiles are longer, have an appetite for long-dated papers. However, even insurance funds’ interest in SDLs is waning.

This was largely on account of the competition initially from oil bonds and subsequently from fertiliser subsidy bonds. Fertiliser bonds, bankers said, currently offered yield in excess of 9.3 per cent.

States, the bankers said, had little flexibility to compete with these instruments for fear of fiscal slippages. Most States had estimated their interest expenditure on market borrowing at about 8.2 per cent for the current financial year.

Offering higher coupons on market borrowings would, therefore, lead to slippages in the targets prescribed in the respective States Fiscal Responsibility and Budget Management Acts.

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