Indian two thousand and five hundred rupee banknotes are arranged for a photograph in Mumbai, India (Photographer: Dhiraj Singh/Bloomberg)  

Uncertainty In State Finances Keeps India’s Bond Traders Worried

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India's sovereign bond yields have started to harden again after a temporary reprieve. That despite the government and Reserve Bank of India’s attempts to ease concerns among bond traders about the lack of demand to absorb the upcoming supply of government bonds.

The central government plans to borrow fewer funds from the market in April-October compared to last fiscal. The RBI has also allowed foreign investors to buy more government and corporate bonds in India. It has also allowed commercial banks to stagger out their bond trading losses over four quarters.

Yet, the benchmark 10-year bond yield has spiked over 40 basis points in the last week. One reason for this could be the higher-than-expected borrowing by Indian states in the first quarter as per the borrowing calendar issued by the RBI, said rating agency ICRA’s Principal Economist Aditi Nayar.

To be sure, unlike the central government, states do not necessarily stick to the borrowing calendar. And so, while the indicative borrowing is “significantly larger” than anticipated, it must be taken with a pinch of salt, Nayar said.

The uncertainty in the bond markets has to do with the timeline of when central taxes will be transferred from the government to states and its impact on states’ cash flows. “There have been some changes that have led to a modification in the expected cash flows of the state governments,” Nayar said.

Earlier the government used to transfer one-fourteenth of the budgeted central taxes to the states on the first day of every month. Adjustments were made to it in the last quarter. Now, for certain parts of the central tax, devolution will happen every month. But for direct taxes, the government will only transfer funds once in a quarter, Nayar said.

That possibly is going to lead to quite a big change in the cash flows of state governments.
Aditi Nayar, Principal Economist, ICRA

This is also in line with the advance tax calendar of the central government as it gets the bulk of funds against these taxes once a quarter. “I guess it’s only fair that devolution of the state governments is going to be once a quarter instead of a month. But this is a pretty substantial change as far as the states’ own cash flow management is concerned.”

That’s the reason why state borrowing numbers have “practically doubled” for the April-June quarter compared to the same period last year, she added.

Watch the full conversation here.

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