State finances: Measuring states the right way

Just how well are the states managing their finances? It turns out there is an easy answer to that one.

Written by Subhomoy Bhattacharjee | Published: October 21, 2013 3:31:41 am

Just how well are the states managing their finances? It turns out there is an easy answer to that one. Just check out how the lenders to the states,in this case the banks price their loans.

It also turns out that this is becoming increasingly easy to measure,rather than calculating the per capita loan outstanding for each state,which frankly measures nothing. Congress general secretary Digvijay Singh has last week used this metric to measure how well states are doing. His logic is,the higher the loan load per head,the worse off is the performance of the state. BJP leaders have predictably raised the decibel level in response but not in the level of clarity they have put in the debate.

Now,after the 12th Finance Commission award,states have to borrow from the market in far larger tranches as the normal assistance from the Centre has been virtually shut off. So by Singh’s logic if a state has a large population but borrows less,it will be better off. Taking this logic to its conclusion West Bengal should be the top of the pops.

But,as we pointed out a far better measure to analyse the fiscal performance of a state government is to watch how the markets price their loan papers. In early October,10 states approached the markets to borrow money with the RBI acting as their banker.

They do this fairly often but the number of states,each a major one going to debt market at the same time made it a very interesting exercise to observe. The sums raised by them were of comparable amounts. The papers floated were also the same 10-year state government papers,with each enjoying an SLR status.

In other words these are the papers for which the banks set aside 23 per cent of the money they can invest in; they are sought after papers. Since each has a sovereign guarantee with the Centre acting as the backstop,the papers should be priced the same,or almost. The surprise is they are not.

The highest yield (a higher yield means lower price for the paper) suffered by a state was not West Bengal but Bihar,at 9.39 per cent. West Bengal came in a shade better at 9.35 per cent. Gujarat papers enjoyed an yield of 9.22 per cent,which means the markets were treating it as aeons ahead in terms of fiscal performance.

Do remember the papers were priced at a free auction. The buyers were predominantly public sector banks and not foreign investors who can be expected to have biases. The public sector banks should know what is happening in the Mantralaya of each state government. Even Gujarat is not the best as far as they are concerned. That accolade is reserved for Tamil Nadu whose debt papers were priced at 9.2 per cent.

Subhomoy is a Deputy Editor based in New Delhi.

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