The Hindu Business Line : States' borrowing costs set to rise

This trend was evident from the wide spreads of Kerala Government's Rs 300-crore borrowings during the week. This issue was placed at 40 basis points (0.4 per cent) over the sovereign issue at 7.48 per cent, when the benchmark ten-year security was quoted at 7.08 per cent. Till recently most State government borrowings were placed only at about 0.25 basis points over the sovereign issues. Last year, in April , the on-tap borrowings of States were priced at only 5.60 per cent or a spread of just 10 basis points over sovereign paper. Bankers said that the hardening was partly on account of resistance from most banks. In fact, few banks were interested in picking up such papers in view of liquidity concerns.

Bankers said that it was the intervention of the Reserve Bank of India that had ensured full subscription to the Kerala State paper.

That the paper initially faced trouble, bankers said, was evident from the high underwriting fees sought by some primary dealers. This resulted in the RBI rejecting all the underwriting bids for the paper.

Sources said that this trend was likely to continue for almost all the State government borrowings. In fact most State government loans are expected to be switched over to the auction route for raising their targeted borrowings. This year, States are expected to raise Rs 29,003 crore directly by way of market borrowings, instead of Central support. A large volume of such borrowings would be through the auction route, bankers said, a departure from the conventional mechanism of placement with the banks, through the on-tap mechanism.

Bankers said that the auction method was also likely to see differential spreads between various States. The fiscally strong States are likely to see lower spreads to sovereign benchmark.

The fiscally weaker States, on the other hand, would have to shell out higher spreads. Despite the changed spreads, bankers said borrowing costs for the States would substantially rise. Part of this trend stems from the fact, that few banks were interested in picking up illiquid securities. In fact most banks have an investment-deposit ratio of a 44-45 per cent and few have the inclination to invest in government securities given this trend. The securities were at best likely to be mopped up only by the life insurance companies, they said. But even the life insurance companies are faced with pressures of rising return expectations from policyholders.

As a result, State government officials expect that despite some of the 12th Finance Commission recommendations allowing for write-off of some portions of the Central loans and debt swaps, States are still likely to face severe revenue deficit pressures, they said.

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