Tamil Nadu’s Borrowing Experience May Set The Stage For Other States
Tamil Nadu has borrowed in the thirty-year buckets across three auctions and has managed to raise funds at attractive rates.
The Indian bond market is offering state governments an opportunity to borrow longer-term funds at a time when overall public sector borrowings are set to surge.
Tamil Nadu has raised funds for a 30-year duration across three auctions and has managed to lock-in attractive rates.
The state has issued bonds worth Rs 4,500 crore in the 30-year bucket out of its total borrowings of Rs 21,000 crore so far this fiscal year. At each successive auction, credit spreads have reduced, falling to less than 10 basis points at the latest sale. Credit spreads are the additional interest rate charged over central government bonds.
Tamil Nadu is the only state to issue state development loans with a 30-year tenor so far this fiscal.
“Today it is all about market segmentation. So more than spreads, state governments don’t want to miss out on any segment of investors and want to satisfy all investor segments,” said Jayesh Mehta, country treasurer at Bank of America. State governments weren’t as active in the longer-end of the curve historically compared to today, he said.
Insurers and pensions funds are large investors in long-term bonds. Bank treasuries have also been buying these bonds due to surplus liquidity.
“This is an extraordinary year when governments both at the centre and states are compelled to borrow a lot more than the usual trend,” said Pankaj Pathak, a fixed-income fund manager at Quantum Asset Management Company Pvt. “State governments need long-term funding, so I think states are spreading their liabilities over the longer term to reduce the burden of debt repayments in a particular year.”
Tamil Nadu’s efforts to borrow more may take a leaf out of the Telangana government’s experience.
In a September 2019 report on state finances, the Reserve Bank of India had cited Telangana as a case study for states looking to stretch out their borrowings over a longer period. Longer tenor bond issuances reduce refinancing risk and locks-in yields when interest rates are on an upward trend, the RBI had said. The strategy can improve the maturity profile of state debt repayments, the central bank said. Telangana has been issuing securities with longer tenors since 2016-17.
Apart from Tamil Nadu, most states continue to concentrate borrowings for durations up to 10 years.
While spreads over central government bonds for this tenor of borrowings have also eased, they remain wider than those sought for 30-year bonds. This may be partially because of the limited supply of longer-term bonds but also because not all states have the same credit metrics.
“The 30-year SDL market is only accessible to a few good quality states that have strong finances. It makes sense for state governments to issue SDLs across the curve because at the end of the day, the spread between the 30-year SDL and 10-year SDL is relatively small,” said Abhishek Upadhyay, senior economist, ICICI Securities Primary Dealership. If states were to issue 30-year SDLs they need to ensure they garner investor support for such long-term bonds, he said.
Central Government Experience
To be sure, the central government has been borrowing longer term funds for some time now and continues to do so.
Of the Rs 2.82 lakh crore worth of government securities issued by the central government between April and June 15, around Rs 33,000 crore bonds were issued with a tenor of 30 years and Rs 29,000 crore bonds were issued at a tenor of 40 years.
During the same period last year, out of Rs 1.85 crore worth of government security issuances, the central government raised Rs 28,000 crore worth of 30-year bonds and Rs 16,000 crore worth of 40-year bonds, according to RBI data.
Mehta said the government is doing a proper study of the market and kept a majority of issuances in the middle 10-15 year bucket. “At this juncture there’s appetite to buy these bonds as duration bonds are providing better returns,” he said. “But if there’s another 50 bps (basis points) rate cut, the entire yield curve will come-off which may reduce the appetite at super long end.”
Additionally, between May and June 17, the government offered to switch Rs 57,000 crore worth of bonds of which close to Rs 27,400 crore was switched to longer-dated securities. “Through the switching strategy the government is spreading out their borrowing programme, because it doesn’t want redemptions to be bunched up in any particular year, especially when net-borrowing will be high for the next couple of years,” Upadhyay said.
Appetite For Long-Term Bonds
While borrowing costs for longer term bonds may be more attractive, the pool of buyers may also be smaller.
“With the central government is expected to continue issuing long-term bonds, there is a concern that there will not be enough appetite to take on such duration risk,” said Pathak. “In the past two months market has comfortably absorbed the excess supply of long-dated bonds but this kind of demand may not sustain once yields start moving up.”
He said much of this demand has come from banks which are currently flooded with liquidity and are extremely risk averse to lend. “But this demand could decrease as their hold-to-maturity investment books are nearly filled, which means that they would have to buy these government securities through their available-for-sale book,” said Pathak. Banks don’t need to book mark-to-market losses on their hold-to-maturity book.
For insurers, the demand depends less on interest rates and more on their portfolio, said Mihir Vora, director and chief investment officer, Max Life Insurance Co. “Credit spreads do not drive the decision making for insurers as there will always be demand for these bonds regardless of the yields. Rather, the decision to buy certain SDLs depends on the insurers’ asset-liability requirements.”
When there was a liquidity crunch in March and April, credit spreads between the government security and SDLs rose, but have since they have normalised since risk appetite is back, he said. “While insurance companies buy central government bonds regularly, we do not buy all SDLs but take selective calls depending on the credit-quality,” Vora said.