The Hindu Business Line : Pricing pressures hit States’ market borrowing plans

Banks’ low interest in State development loans was in view of their high investments portfolio. Banks currently have an investment-deposit ratio of 34 per cent.

C. Shivkumar

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Bangalore, May 22 Pricing pressures have hit the State Governments’ market borrowing programmes despite a liquidity overhang.

Bankers said that there was little interest in State development loans (SDLs). This was despite the fact, that the SDLs are also sovereign guaranteed papers and eligible for maintaining statutory liquidity ratios. SDLs are currently trading at a spread of about 40-55 basis points over comparative sovereign bonds.

The high spreads varied depending on the issuing States. States with interest over-dues tend to have higher spreads and vice versa.

In fact, at the last SDL auction on April 22, the coupons ranged between 8.5 and 8.6 per cent. At that auction, the highest yield offered was on the West Bengal SDL at 8.6 per cent, the lowest was on Uttarakhand at 8.5 per cent.

But traders said that despite the high coupons, interest in SDLs was waning. This was despite the liquidity overhang in the banking system. In fact, traders said that even insurance companies, traditionally the large investors in SDLs, evinced little interest. The reduced interest in SDLs stemmed largely from competition from oil bonds placed in the secondary markets by refineries for meeting their respective working capital requirements. Oil bonds are also sovereign guaranteed.

Currently, oil bonds are offered by the refineries at spreads anywhere between 80 and 100 basis points over sovereign borrowings, which translated into yields of over 9 per cent.

Banks’ low interest in SDLs was also in view of their high investments portfolio. Banks currently have an investment-deposit ratio of 34 per cent. This is well over the prescribed statutory liquidity ratio (SLR) of 25 per cent. Moreover, bankers said that with deposit intake being reduced, there was little need for additional investments in SLR securities.

Higher coupons

Consequently, State Government market borrowings are likely to be faced with bids at higher coupons.

Price bids for future issues are likely to translate into coupons of over 9 per cent, implying an escalation in the cost of borrowings for the State Governments to match the competition from oil bonds, bankers said.

The escalation in costs was already evident at the auctions on April 22, when interest on market borrowings cost higher than small savings schemes. Small savings rates are currently at 8.5 per cent.

But such high-cost market borrowings by States are expected to have a major fiscal impact during the year.

Almost all the States have factored in their interest costs assuming an average cost of 8 per cent. If costs rise beyond this level, then States are likely to face an increase in revenue expenditure.

The alternative would be to switch over to small savings that have shorter tenures of just five years, unlike SDLs which have 10 years. States like Karnataka raise more borrowings through small savings instead of market borrowings in view of the lower costs and shorter tenures. More States are now likely to look at this option.

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