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

Higher Taxes From Oil, Rising Interest Rates Keep State Borrowings In Check

States have borrowed only about half of what they had indicated at the start of the April-June quarter, as increased tax collections from petroleum products allowed them to turn away funding at higher costs.

In the ten auctions of State Development Loans (SDLs) held between April-June 2018, states borrowed Rs 66,788 crore, shows data collated by BloombergQuint. This is only about half the borrowing amount of between Rs 1.16 lakh crore and Rs 1.28 lakh crore indicated by states at the start of the quarter. The final SDL auction of the quarter is scheduled for June 26, in which banks are indicated to borrow up to Rs 7490 crore.

“We may end this quarter with just a jump (in state borrowings) of 12-13 percent percent, which is a far cry from the doubling of borrowings that was indicated in the calendar put out by the RBI,” said Aditi Nayar, prinicipal economist at ICRA.

The borrowing amounts indicated by states in April were nearly double of what they had borrowed in the first quarter of last year. This had spooked bond markets and added to concerns of an over-supply of government bonds at a time when demand is weak.

However, states have managed to contain these borrowings.

One reason for this is that higher oil prices led to increased tax revenue from petroleum products. Also, after a period of uncertainty on the timeline for devolution of central direct taxes, the union government has said that states will get their share on a monthly basis.

The value added tax levied by state governments, is an ad-valorem tax. As oil prices have risen, VAT collections have followed and states have benefited, said Devendra Pant, chief economist at India Ratings. He added that GST collections have also been stronger than in past months, easing pressure on state finances.

Borrowing costs for states increased by 40-60 basis points over the April-June quarter, in line with the increase in the benchmark central government bond yields. Given the improvement in revenue balance of states, they were in a position to turn away higher cost borrowings.

Data on individual auctions shows that states borrowed a fraction of the planned amount at each auction. The data shows that adequate bids were received to cover the planned borrowing. However, states avoided accepting bids at the elevated rates, said Pant.

Interest on state development loans is typically at a spread of 40-50 basis points over benchmark bonds. Additionally, buy backs by the central government are common but are minimal in case of state governments. Borrowing at these rates could have a negative impact on the state’s finances.
Devendra Pant, Chief Economist, India Ratings and Research