State governments faced higher borrowing costs this week as yields on government securities surged sharply, due to diminishing expectations of further rate cuts by the Reserve Bank of India (RBI). The sharp rise in bond yields has made market borrowing more expensive, adding pressure to state finances amid shifting monetary policy outlook.
According to RBI data, borrowing cost for states through state development loans (SDL) rose by 10-27 basis points (Bps) since last week. The rise was witnessed mostly after the central bank kept repo rate unchanged in August monetary policy.
The cut-off yield on the 30-year SDL was set at 7.43 percent at weekly auction on August 12, as compared to 7.16 percent in previous week’s auction. Similarly, cut-off yield on 15-year SDL was set at 7.35 percent this week, as compared to 7.22 percent last week, RBI data showed.
Experts also attributed the rise in borrowing cost to the heavier SDL supply pipeline compared to last year, rupee depreciation pressures, and a clear investor preference for shorter maturities.
Venkatakrishnan Srinivasan, founder and managing partner of Rockfort Fincap LLP, added that the upward pressure is further compounded by global uncertainties including rising tariff concerns, lingering geopolitical tensions, and volatile market conditions which are keeping risk premiums elevated.
In this week’s auction on August 12, six states have borrowed Rs 8,450 crore via SDL.
Government bond yields have been on the rise since the RBI’s status quo in the August monetary policy. Though the decision was in line with the market expectation, few participants expected a surprise rate cut.
On August 12, 10-year benchmark government securities yield ended at 6.492 percent, which was over four months high. Today, it traded at 6.4684 percent.
Usually, when the yield on the government securities rises, other money market instruments yield follows the movement.
Interestingly, these developments are unfolding despite continued surplus liquidity in the banking system, typically a factor that would ease borrowing costs. However, the current market environment shows that term-premium demands and risk aversion are outweighing the comfort provided by liquidity.
Money market experts are of the view that borrowing cost of states to remain elevated especially at the longer end of the yield curve. With the RBI unlikely to cut rates in the near term and supply pressures showing no signs of easing, the fiscal dynamics for many states could tighten further.
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