‘To achieve States’ FRBM target, primary deficits must be set right’

While market borrowing provides easy access to finance for States, the present lack of incentives to undertake fiscal reform so as to earn lower spreads could render State finances vulnerable to debt sustainability concerns, according to the Reserve Bank of India’s report on State finances.

Steadily rising yields on State Development Loans (SDLs) imply the need for larger and faster corrections in primary deficits than before so as to adhere to the revised Fiscal Responsibility and Budget Management (FRBM) target of 20 per cent for the State-level debt to GDP ratios by 2024-25, it added.

“However, attaining this in a scenario of large committed expenditure could lead to compromise on the developmental and capital expenditure, which may not be desirable from a long-term growth perspective. Hence, re-prioritising State expenditure and improving their efficiency will be necessary to sustain growth while maintaining fiscal prudence,” the central bank said.

The maturity profile of States’ debt indicates near- to medium-term redemption pressures, which is likely to rise continuing from the current year and reach a peak in 2026-27.

At the end of March 2018, 67.2 per cent of the outstanding SDLs were in the residual maturity bucket of five years and above. About 16.7 per cent of outstanding SDLs will mature in the next three years, keeping redemption pressure high in the near future.

Large issuances of SDLs, among other factors, have been exerting upward pressure on yields, with the weighted average yield on the State government securities increasing to 7.60 per cent in 2017-18 against the 7.48 per cent witnessed during 2016-17. The average spread of SDL yields over corresponding maturity Central government security (G-sec) yields remained at elevated levels over the last few years, the report said.

Investments in SDLs

Banks’ investments in SDLs have risen from 16 per cent of total government securities in early 2000s to about 24 per cent during 2017. Within the total holding, there are notable bank group-wise variations.

While the share of public sector banks is higher at above 30 per cent of the total government securities, it is about 10 per cent for private banks and almost negligible for foreign banks.

“While the supply and demand for SDL issuances remains high, the secondary market liquidity of SDLs is low. Daily average turnover of SDLs in the secondary market is about one-tenth of that for Central government securities.

“Looking at the turnover ratio measured as SDL traded volume scaled by outstanding stocks, it is observed that SDL liquidity is very low vis-à-vis Central government securities,” the RBI said.

On the demand side, the demand for SDLs from commercial banks emanates from regulatory prescriptions – Statutory Liquidity Ratio (SLR), Liquidity Coverage Ratio (LCR) and normal investment demands.

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