COVID-19 has put severe stress on the economy of the country affecting the tax revenues of both the centre & the states. Data from the RBI indicates that the states have borrowed 50% more amount through State Development Loans (SDLs) in the first four months of 2020-21 compared to the same period in 2019-20.
As part of its 5th tranche of announcements of ‘Atma Nirbhar Bharat Package’, the Government of India has decided to allow the states to increase their borrowing limit from 3% to 5% of GSDP. This would allow states to go for external borrowings to generate additional resources at a time when the economy is going through a crisis.
The lockdown imposed across the country due to COVID-19, and extended lockdowns in few of the States due to higher prevalence of COVID-19 have had a negative impact on the economy. The revenue sources of not only the Centre but also that of the states have been severely affected. Similar to the Centre, each of the states have their own budgeted expenses which they plan to meet through the various sources of revenues. Lesser revenue generation would mean that the states would not be able to finance their planed expenditure and implement various schemes.
The states try to bridge this deficit by seeking loans and other financing options from external sources. However, there is a statutory limit on the extent to which the states can borrow to ensure fiscal stability. The decision of the central government to extend this statutory limit to 5% of GSDP, provides the states more room to raise funds during this pandemic.
States compensate a major portion of Fiscal Deficit through Market Borrowings
One of the key targets of FRBM Act (Fiscal Responsibility and Budget Management Act, 2003) was to limit the Fiscal deficit of the states to 3% of GSDP. In an earlier article, we have observed that the GFD (Gross Fiscal Deficit) as proportion of GSDP varied for different states in terms of meeting the limit set by FRBM Act.
In another story, we noted that there is a fall in GST revenues of the States, which form a major source of State revenues. This puts further pressure on the already strained State budgets which are already suffering from fall in State’s Own Tax Revenue (SOTR).
An analysis of Financing of this deficit (GFD) by the states as per the actual accounts submitted for 2017-18, indicate that around 84% of the GFD of the states is financed by Market Borrowings. The budget estimates for 2019-20, peg the share of Market borrowings at 87.9% of the total financing for GFD.
SDLs enable states to raise funds through Market borrowings to fill the gap
National Small Savings Fund (NSSF) and Central Government loans were the major options for state governments to seek the funds for deficit financing. In accordance with the recommendations of the 14th Finance commission, the government of India has approved discontinuation of states seeking loans through the high-cost NSSF. This has encouraged the states to rely on State development loans (SDLs) as major source of funds for deficit financing.
What are SDLs? How do States raise the required funds through the SDLs?
State Development Loans (SDL) are debt issues by the state governments to fund their fiscal deficit. The issue of SDLs is managed by the RBI. It also takes up the responsibility of ensuring the SDLs are serviced by monitoring escrow accounts for payment of interest and principal. SDLs encourage the states to have a better fiscal strength, since the higher the Fiscal strength of a state, the lesser the interest rate/yield that it has to pay.
SDL offers two main advantages which encourage investors to invest in them and help the state governments to raise the required market borrowings to meet the budgetary requirements.
- Higher yield
- SDLs are similar to Central Government Securities, and do not have Credit risks.
Most of the investors of SDLs are Commercial banks, Insurance companies etc. who are looking for a higher yield on investment. Since 2014, the government has also allowed Foreign investments in SDLs.
Auction and Trading of SDLs
The auction of SDLs is held fortnightly by the RBI. In each auction, a fresh set of 10-year bonds are issued (few states issue bonds which have lesser tenure ). Various institutions participate in the bidding process and bid for the respective state bonds which are available in the auction.
The maturity and the bond yield play a key role in the choice of state bond that the investors are likely to bid for. The bidding process is facilitated through RBI’s Core Banking Solution System (E-Kuber). The securities are issued at a minimum nominal amount of ₹ 10,000 and further in multiples of ₹10,000. RBI determines the maximum yield/minimum price limits at which the yields are accepted. The results are announced by RBI as per a pre-determined date.
SDLs qualify as approved SLR (Statutory Liquidity Ratio) security under Section 24 of Banking Regulation Act, 1949. SDLs can be traded electronically on NDS-OM (Negotiated Dealing System- Order Matching) , similar to that of Government Bond Market.
Nearly 50 % increase in borrowings through SDLs in 2020-21 so far
As discussed earlier, there is a severe strain on the finances of the various state governments because of COVID-19. Trends of recent years suggest an increase in the preference of the states to go for SDLs.
The need of the states for higher market borrowings is evident through the increase in funds raised through SDLs in the current financial year of 2020-21 (until the first week of August 2020), compared to the same period last year.
For the period April-August’2020, a total of ₹ 2.15 lakh crores was raised through SDLs by various states. During the same period last year (2019-20), the total amount raised until first week of August was around ₹ 1.45 lakhs crores. What it means is that the states have raised close to 50% more amount through SDLs in the first four months of 2020-21 compared to the first four months of 2019-20.
In the current financial year i.e. 2020-21, the highest amount was raised in April 2020 with around ₹ 55 thousand crores. In the subsequent three months i.e. May-July, the amount raised was around ₹ 44-45 thousand crores raised in each of the months. During the first auction of August 2020, an amount of around ₹ 12 thousand crores was raised by states.
When compared to 2019-20, except for July, the monthly amount raised via SDLs has been higher in the current year, 2020-21. The difference been more significant for the months of April 2020 and May 2020, when there was a near complete lockdown.
In the next part of this story, we explore debt situation of the states in detail by looking at the trends in market borrowings through SDLs over the years including the share of SDLs in their respective GSDP, the overall debt situation of the states etc.