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C. Shivkumar

Bangalore, July 7 Borrowing costs for States are expected to escalate sharply as competition from the Centre’s borrowing programme for the current year mounts.

The Budget allows States to raise their fiscal deficit target to 4 per cent of their respective Gross State Domestic Product (GSDP), as part of a one-time exception to the Fiscal Responsibility and Budget Management Act. This gives an additional window of 0.5 percentage points for State Governments to tap the financial markets.

Most States are expected to raise funds through State Development Loans (SDLs). However, additional borrowings are unlikely to come cheap.

One reason for this is that the Centre’s borrowings have been hiked to Rs 4.51 lakh crore or a Rs 90,000-crore increase over the estimates made in the Interim Budget for the current year. This year, so far, the Government has completed only Rs 1.69 lakh crore or 37 per cent of its revised borrowing target. The increased borrowings have now pushed up the Centre’s public debt to 43 per cent of the Gross Domestic Product for the current year.

Government borrowings are already taking place at the rate of Rs 15,000 crore per week. This pace is expected to be sustained for most part of the year. But the stepped up borrowings have already been discounted by the markets, as is evident from the steep ascent in yields. The keenly watched ten-year Yield to Maturity (YTM) is currently over 7 per cent or a 30 basis points increase over last weekend. The yield spike was despite the liquidity overhang in the banking system, as is evident from the daily liquidity adjustment facility auction.

At Tuesday’s LAF auction, recourse to the reverse repurchase window amounted to Rs 1.39 lakh crore. However, the heightened pace of borrowings of the Centre is likely to escalate costs for the States.

SDLs are normally done for periods of 10 years. SDL yields, despite the sovereign guarantee cover, are priced at least 50 basis points over identical government securities under normal conditions. But these spreads have widened to 90 basis points, after the Budget’s increased borrowing programme for the current year. At Tuesday auctions of SDLs, the weighted YTM was 7.91 per cent, as against the 10 year YTM of 7.02 per cent.

As a result, States’ interest costs in the current year are likely to sharply escalate. This has led to some caution among some States such as Karnataka.

A top official said, “We will have to incur higher interest rates. But we will not borrow immediately and will prefer to wait for some more time.”

Despite the caution, the States think SDL rates could overshoot budgeted estimates of 6.5 -7.25 per cent. SDL yields are estimated to overshoot 8 per cent or close to the small savings interest rates.

More Stories on : States | Financial Markets | Govt Bonds

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