States’ borrowing costs may rise further in coming auctions, say experts

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The borrowing costs of states is likely to rise in the coming auctions, with the quantum of rise hinging on the size of issuances and overall rising interest rate scenario, experts said.

“The yields will continue to fluctuate depending upon the issuance size of the SDL (state development loan) auction every week.  Whenever the scheduled SDL auction amount goes above Rs 20,000 crore, the yields tend to go upwards,” said Venkatakrishnan Srinivasan, founder and managing partner, Rockfort Fincorp.

In the last four weeks, the weighted average yield on the 10-year SDL has risen by 5-7 basis points. At the February 14 auction, the cut-off yield on the 10-year SDL ranged between 7.71 and 7.72 percent.

According to money market dealers, the average of the 10-year SDL cut-off on January 24 was 7.65 percent, on January 31 it was at 7.67 percent, 7.66 percent on February 7 and 7.72 percent on February 14.

A state development loan is a bond issued by state governments to fund their fiscal deficit. SDLs pay interest on a half-yearly basis and repay the principal on maturity. State government borrowings are an essential part of the budgetary resources raised by respective states to fund their development activities.

“As a result of the rising overall interest rates, the yields on SDLs have also increased and firmed up,” said Jyoti Prakash Gadia, managing director at Resurgent India, a Securities and Exchange Board of India-registered merchant banker.

“The rates are again likely to go up given the total rise in borrowings expected in the short run and given limited resources available,” Gadia added.

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SDL issuances

According to the Reserve Bank of India’s (RBI) website, 12 states had planned to raise Rs 12,200 crore, but they ended up raising Rs 11,900 crore. Uttarakhand has not accepted any amount in the 10-year security.

During the February 14 auction, Uttarakhand has not accepted Rs 300 through 10-year security.

Since the start of this calendar year, all SDL auctions have been fully subscribed, except on February 14.

“Borrowing was around Rs 12,000 crore in the February 14 week. Tax collections of states have improved, plus there has been support from the central government. Hence, borrowing might be in line with the calendar or lower,” said Marzban Irani, chief investment officer, fixed income, LIC Mutual Fund.

Experts believe that the borrowing by states is likely to remain lower for at least a few months unless states foresee any urgent requirements.

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Spread

With the rise in yields on the SDLs, the spread between the 10-year benchmark government bonds and SDLs increased to 38 basis points on February 14, from 33 basis points in the prior two weeks.

On January 24, spread was around 30 basis points.

Spread between two securities refers to the difference between the interest rates on these securities.

Going ahead, according to Srinivasan, the spread may widen when auction supply increases or goods and services tax revenue goes down over the period.

Gadia added that the spread is expected to vary depending on the quantum and timing of the borrowings and that the fundamentals of the state government also play a significant role in determining the spread.