Why It’s Still Expensive for States to Borrow Money as Covid-19 Cuts Interest Rates


New Delhi: Faced with a sharp contraction in income accompanied by increased spending to combat the Covid-19 pandemic, many Indian states have been forced to borrow at significantly higher interest rates in the market.

This comes at a time when the Reserve Bank of India (RBI) has cut interest rates sharply to fight the pandemic. The repo rate or the rate at which banks borrow from RBI is as low as 4.4% right now.

RBI data shows that the average yield on state government bonds was around 7.7-8%. The yield on the 10-year benchmark paper or the rate at which the central government borrows in the market was 6.46%. This means that state governments are borrowing at an interest rate at least 1.3 percentage points above the Centre’s interest cost.

Analysts point out that higher returns can be attributed to markets expecting the states and the Center to borrow more than budgeted due to the sharp increase in spending stemming from Covid-19.

Soumyajit Niyogi, associate director at India Ratings and Research, said bond markets expect central and state governments to borrow more due to liquidity crunch due to lower revenues and higher spending. , driving up bond yields.

“Due to the expectation that the government will borrow more this year, the yield on the 10-year g-sec (government securities) rose to 6.4%. Typically, state governments are able to borrow at 30-50 basis points more than the g-sec yield. But in times of crisis or uncertainty, governments’ borrowing costs increase and this gap increases. This is what is happening now with spreads well over 100 basis points,” he said.

Niyogi said state governments had no choice but to raise funds from the markets as they had limited sources of revenue. He added that state governments typically borrow less in the first half of the fiscal year, but that is expected to change this year.


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State borrowings

To counter cash flow problems, state governments borrowed more than Rs 44,000 crore in the first two weeks of April, according to RBI data.

As many as 19 Indian states including Maharashtra, Kerala, Tamil Nadu, Karnataka, Haryana, Gujarat and Madhya Pradesh borrowed Rs 32,560 crore from the markets on April 7, with an average return weighted on 10-year papers of around 7.7-8% in all states.

Yields fell slightly to 7.6-7.7% when nine of these states borrowed about 12,000 crore rupees on April 13, the data showed.

State governments have been allowed to borrow a total of Rs 3.2 lakh crore during the April-December period by the central government.

The rise in yields on state government bonds stands in stark contrast to the performance of yields in 2019-20, when weighted average yields on state development loans fell from around 8.2% to around 7.2%.

State governments saw their borrowing costs rise in March even as yields started to rise.


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Calls to ignore FRBM rules

On Friday, the RBI raised the limit for states to borrow under Ways and Means Advances by 60% from March 2020 levels. This will be permitted until September and “will provide greater comfort states to undertake COVID-19 containment and mitigation efforts, and to better plan their market borrowing programs,” the bank said.

The move came even as states expressed concerns about rising borrowing costs. Bihar Deputy Chief Minister Sushil Modi told ThePrint in an interview this week that fiscal uncertainty has worsened due to the coronavirus and “states are borrowing at higher rates in the market.”

“The borrowing rate has gone up and there are fewer government bond buyers,” he said, adding that the RBI should start buying government bonds.

On April 10, Kerala Finance Minister Thomas Isaac cited the large difference between repo rates and state development loan yields to seek monetization of the deficit through the central government, ignoring the rules of the Fiscal Responsibility and Fiscal Management (FRBM) Act and borrowing directly from the Central Bank.

Speaking at a seminar on Tuesday, HDFC Chairman Deepak Parekh presented a similar case. He highlighted how yields have gone up and not down despite RBI’s repo rate cuts. Parekh recommended that the central bank buy corporate bonds and treasury bills directly, as primary markets have shut down. Globally, all countries do so to finance economic activity, he added.

HDFC has announced its intention to raise funds at a coupon rate of 7.2%.

Indian states that are at the forefront of the battle against Covid-19 have asked the Center for increased financial support, including the release of financial grants due to states sooner than expected, allowing them to borrow more and easing the 3% ceiling on the budget deficit as a percentage of GDP and the timely payment of goods and services tax (GST) compensation.

The central government, for its part, agreed to some of the demands. This published GST compensation to the states for the months of October and November amounting to Rs 14,103 crore. This also published Rs 17,287 crores to states under various headings to help fight Covid-19.


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