Higher borrowing by states to widen yield spread with G-sec

The higher supply of state government securities along with G-sec supply is expected to weigh on state government bonds this quarter, with higher borrowing expected to lead to a rise in the borrowing cost for states compared with Centre. The weighted average cut-off of state government securities increased by a sharp 8 bps to 7.71 per cent on Tuesday from 7.63 per cent last week and the spread between the cut-off of 10-year state government securities and the 10-year G-sec (7.18 per cent, 2033 bond) yield widened to 53 bps on Tuesday from 48 bps last week, highest since January 2022, ICRA said.

“In our view, if the weekly SGS auctions in Q4 FY2024 are closer to the indicated amount, the spreads between the 10-year SGS and 10-year G-sec yield may widen to 50-60 bps in this quarter, especially in February-March 2024,” Aditi Nayar, Chief Economist, ICRA said.

Last week, the Reserve Bank of India had released the indicative calendar of market borrowings by state governments and union territories (UTs), wherein a record borrowing of Rs 4.13 lakh crore has been proposed by states and UTs in the last quarter of this financial year, over 37.4 per cent higher year-on-year. Estimates by economists had pegged states’ borrowing to be around Rs 3.4-3.5 lakh crore in Q4. Among states, Karnataka, West Bengal, Madhya Pradesh and Tamil Nadu constitute the majority share in the proposed borrowing, with Karnataka and West Bengal accounting for nearly 80 per cent of the incremental indicated borrowing amount of Rs 1.1 lakh crore for Q4. However, the actual borrowing by states could turn out to be lower than the indicated borrowing. ICRA said some states may have estimated their Q4 borrowing by subtracting their actual issuance in nine months so far from the total permitted borrowing for FY2024 by the Government of India. Release of additional funds under the capex loan scheme in Q4 and tax devolution could also help limit the total states’ borrowing, it said.

After a gap of 10 quarters, the actual borrowing by states had exceeded the indicated amount by 4 per cent or Rs 8,700 crore in October-December. The total borrowing by states in April-December stood at Rs 6 lakh crore, 90 per cent of the amount indicated for this period (Rs 6.7 lakh crore) compared with 70 per cent in the year-ago period (Rs 4.6 lakh crore actual borrowing vs Rs 6.5 lakh crore indicated).

Though the Centre has given two advance instalments of tax devolution to states/UTs by December-end, a slower nominal GDP growth, moderation in indirect tax and own tax revenue of states and grants by Centre are being seen as the likely factors to have pushed states to indicate higher borrowing. “Grants from Centre are tracking 26.4 per cent YoY lower in FY24 (Apr-Oct) v/s full year budgeted growth of 24.6 per cent in FY24 Budget Estimate. Grants from Centre consist of Central sector schemes, centrally sponsored schemes, finance commission grants and GST compensation cess. A part of the decline was expected with the discontinuation of sharing of GST cess revenue with states since June 2022…the sharper than budgeted decline is likely due to reduction in 15th Finance Commission Grants. Data from Centre (Department of Expenditure), indicates a 31% YoY decline in FY24 (Apr-Nov), led by revenue deficit grants and grants for rural bodies,” Sen Gupta said.