Huge issuance of state loans may raise borrowing cost for corporates

States are elbowing out corporate firms from the money market. As borrowing by states balloons and matches that of the Centre’s, corporate entities are likely to feel the heat, especially with their widening spread over benchmark government bonds refusing to come down.

The spread between 10-year corporate bonds and benchmark 10-year government bonds is now about 100 basis points and has been in this territory since the Infrastructure Leasing & Financial Services (IL&FS) crisis. Huge issuance of state development loans (SDLs), or bonds issued by states, has only compounded this problem.

On a gross basis, states are estimated to borrow between Rs 5.5 trillion and Rs 5.7 trillion in the next fiscal year. While this would be lower than the Centre’s, the states’ gross borrowings would still be almost at par with the Centre’s gross borrowings of Rs 5.9 trillion in 2017-18.

The high borrowing is going to put a lot of pressure on the corporate borrowers, say experts. Especially if the foreign portfolio investors (FPIs), who have been shy so far in taking exposure to corporate bonds, move to SDLs.

FPIs have just utilised 5.6 per cent of their investment limit in SDLs. 

They are allowed to invest up to Rs 38,100 crore in SDLs, against which they have invested only Rs 1,938 crore.

States’ issuance of discom bonds has also worried the FPIs and they see the huge issuance as a potential stress.

What is more concerning for the investors is that a huge chunk of debt borrowed is used to service old debt, making the whole scheme unsustainable.

The FPIs, according to sources, were not too keen on investing in SDLs, considering the sketchy accounting profile. However, that may change as the Reserve Bank of India comes in with steps that identifies states with their finances and allows the market to fix pricing accordingly.

So far the corporate bonds have done well because of the FPIs’ interest in this segment, and their aversion for state loans. 

However, if they start taking an interest in state loans, corporate entities in India will suffer.

Presently, FPIs have exhausted 70.3 per cent of their limit of Rs 2.89 trillion in corporate bonds.