The Hindu Business Line : States’ finances face strain

With interest rates hardening, States are faced with fiscal deterioration this financial year. Sources said that most of the States had budgeted their borrowings for the current year on the assumption that borrowing costs would be in the region of about 8-8.25 per cent. This was on the basis of the ten-year yield to maturity that ranged between 7.5 and 8 per cent in April this year.

State government borrowings in the form of state development loans (SDL) are usually priced at about 40-50 basis points over the ten-year sovereign yields. Between April and August this year, the 10-year yield to maturity has escalated by at least 170 basis points.

As a result, SDL yields moved up to 9.3 per cent at the last auction on August 26. But official sources said the increase in rates was unlikely to impact the older series of borrowings. For fresh borrowings, borrowing costs, however, would escalate, the sources said.

Maintaining SLR

Bankers said that the only interest in SDLs was for maintaining their respective statutory liquidity ratios (SLR). In addition, SDLs were also eligible securities for the RBI’s repurchase operations. As a result, only public sector banks picked up the securities, mostly for meeting their reserve ratio requirements.

But non-banking financial intermediaries, such as mutual funds, insurance companies and provident funds, were less inclined to pick up SDLs, bankers said. The low interest in SDLs also stemmed from competition from special government securities, such as subsidy bonds, (securities issued to oil fertiliser and FCI entities against subsidy dues).

The distinction was in view of the fact that the special securities were sovereign securities, whereas SDLs were sovereign-guaranteed securities. As a result, the spread over sovereigns for special government securities were just 20 basis points. The spread for SDLs were 50 basis points, despite their status as SLR securities.

Besides, bankers said that on some of the SDL securities, debt servicing payments were in arrears. The payments could be recovered only if the sovereign guarantee was invoked. Delays in debt service payments, bankers said, led to liquidity problems for investors in SDLs, the bankers said.

risk premium

Moreover, this year, SDLs were likely to face higher risk premium over sovereign issues, the bankers said. This was largely in anticipation of tax collection shortfalls as a result of the industrial slowdown.

Consequently, States, along with high interest payouts, revenue falls were expected to hit their respective revenue receipts. In addition, inflation pressures have also increased the State’s wages and pension liabilities. Wages and pension liabilities for most States are at least 40 per cent of their respective revenue expenditure.

Tapping small savings

Alternatively, some of the States, especially those in the South, have begun containing their capital and revenue expenditure. More States are now tapping the small savings for their borrowing requirements in view of the lower costs.

Small savings currently cost only about 8.5 per cent. But this source is beginning to dry up in view of competition for resources from the banking sector. Banks are currently offering returns in excess of 9 per cent for 5-year deposits.

More Stories on : Financial Markets | States | Interest Rates

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page