States' market borrowings to jump by 22% next fiscal

Even as the Centre has contained its fiscal deficit at 3.2% for FY-18, the states are looking the other way and their gross market borrowings next financial year are estimated to jump by nearly 22% to Rs 4.5 trillion, says a report by rating agency Icra.

The massive rise in market borrowings by the states is due to their higher fiscal deficits, higher repayment burden, exclusion from the national small savings fund (NSSF), higher salary outgo arising from the seventh pay commission awards and the note ban impact on their revenues, as per Icra.

"Gross market borrowings by the states are likely to rise from Rs 3.7 trillion in fiscal 2017 to Rs 4.5 trillion in fiscal 2018, which would exert an upward pressure on yields of state development loans (SDL) in fiscal 2018," warns Jayanta Roy, group head for corporate sector ratings at the agency.

But if the states' net borrowings remain unchanged at 2.2% of GDP, and assuming that the nominal GDP grows by 11.2% in fiscal 2018, Icra expects net borrowings by the states to jump to Rs 3.8 trillion from Rs 3.4 trillion in fiscal 2017, he says.

But the SDL redemptions are set to more than double to Rs 0.7 trillion in fiscal 2018 from Rs 0.3 trillion in fiscal 2017. Accordingly, the states' gross market borrowings will rise by nearly 22% to Rs 4.5 trillion in fiscal 2018 from Rs 3.7 trillion in fiscal 2017, he said.

Roy attributes the likely massive spike in states' fiscal deficits to the seventh pay panel award, servicing cost of the Uday bonds rise in debt repayment from next financial year onwards and exclusion of most states from investing in NSSF since last April.

"The rise in borrowings of the states would exert an upward pressure on SDL yields in fiscal 2018. Factors such as sluggish capex and less attractive interest rates have contributed to subdued demand from the private sector for bank credit, which may encourage banks to invest in SDLs as they offer higher interest rates than the G-secs," Roy said.

The rising supply of SDLs may constrain the space for the private sector to access better-priced funds from the bond markets, he warned.

The gross market borrowings by all the states, including Puducherry, through SDLs in fiscal 2017 soared 27.1% to Rs 3.2 trillion till February 14, 2017 from Rs 2.5 trillion a year ago, and have already exceeded the Rs 2.9 trillion raised during April 2015-March 2016. This sharp jump in SDL issuances, according to Roy, is due to the flexibility to some states to borrow an additional up to 0.5% of gross state domestic product (GSDP), above the anchor of 3% of GSDP, as recommended by the 14th Finance Commission report.

Icra expects the states to raise additional SDLs of Rs 0.5 trillion in the remainder weeks of this financial year, taking their gross market borrowings to Rs 3.7 trillion. The states have a net repayment liability worth Rs 0.3 trillion in fiscal 2017. This will total up Rs 3.4 trillion to their SDL stocks, which is equivalent to 2.2% of GDP, and a significant 30.4% higher than the net SDL of Rs 2.6 trillion raised in fiscal 2016.

Also, most states are out of the NSSF, which has raised their reliance on bond markets. Nevertheless, as the cost of market borrowings is lower than the special state government securities issued by the NSSF at 8.8% in fiscal 2017, this shift would serve to moderate states' borrowing costs, Roy said. Moreover, he said the impact of the note ban on the states' own revenue may have increased their borrowings as well. The softening of bond yields after the surge in bank deposits may have encouraged states to lock in lower rates.

It can be noted that tracking the falling G-sec rates, average yields on 10-year SDL slipped from 8% in April 2016 to 6.9% in November 2016, before rising to 7.6% in February 2017. Notably, the average spread of the 10-year SDL yields over the 10-year G-sec has widened to 60-75 bps in the last two months from 40-50 bps in the first half of fiscal 2017 and this is likely to go up further due to the rise in supply of state government debt in fiscal 2018.