Cash-squeezed states pay a steep price

MUMBAI: State governments’ borrowing costs surge as many investors drop out of bond auctions due to lockdown and fears that there could be a surge in their borrowings in coming months as they are squeezed by sliding revenues and higher expenses to treat the pandemic.

Spreads - the difference between central government borrowing cost and state governments’ - more than doubled to 200 basis points this week with the Kerala state bearing the brunt. A basis point is 0.01 percentage point.

“State governments bonds are suffering from thinning market participations,” said Ajay Manglunia, managing director and head – fixed income at JM Financial. “Such abnormal yield levels will likely distort the corporate bond market. Yields should fall once lockdown eases paving way for more market participations.”

At an auction of states bonds conducted by the Reserve Bank of India on Tuesday, investors bid up the yields amid absence of many in the Primary Dealership and big banks.

Kerala sold bonds maturing 2032 at an yield of 8.1 percent, and bonds maturing 2035 yielded as high as 8.96 percent, data from the RBI shows. A 10-year bond sold by Nagaland was bought at an yield of 8 percent, compared to the benchmark central government bond yield of about 6.41 percent,

States including Tamil Nadu and Andhra Pradesh are set to raise about Rs 13, 128 crore coming Monday.

Regional governments are bearing the brunt of the sudden fall in revenues and a surge in their expenses as they remain in the frontline in the fight against Covid-19. They have already been under pressure with slowing transfer for funds from the central government due to lower than estimated Goods and Services Tax collection.

Punjab has demanded urgent release of funds and Telengana has sliced and deferred the payment of salaries to government staff. Kerala Finance Minister Thomas Isaac has sought a relaxation in the rule capping states’ fiscal deficit at 3 percent of the state output.

Country’s largest insurer LIC of India along with large some large pension funds were absent in the auction, dealers said.

The differential or spread between 15-year Kerala papers and the central government equivalent papers surged more than 200 basis points. The gauge was less than 90 basis points immediately after RBI slashed the benchmark rate to more than a decade’s low.

“Cash-rich buyers are now working with limited operational capacity while state governments need money to fight out COVID19,” said Ritesh Bhusari, deputy general manager at South Indian Bank. This led to abnormal rates in those near-sovereign papers.”