States facing tremendous pressure from Negative Carry, that now stands at 183 bps (Part 2/2)

Impact: Negative (State Finances); Negative (Combined Center + State Fiscal Deficit)

Brief: Current bottlenecks in project completion is having a negative impact on state interest payment obligations - as apparent from the burgeoning Negative Carry, currently standing at 183 bps. We reckon that unsupportive public as well as underwhelming private participation is a probable reason behind this anomaly. Using RBI data, we reckon that as on Q1 FY19, the Negative Carry obligation is over Rs. 40 billion for States.

It is already apparent that the Government expenditure is the primary sustainer of the Indian economy at this time. As we suggested earlier, Government Final Consumption Expenditure (GFCF) now contributes to over 11% of the Indian GDP (from the Aggregate Demand perspective) as of Q1 FY19. This means that a lot of money being spent by center and states has to be raised from the market and ultimately becomes part of deficit financing. Even though, the GST implementation has increased Government Revenue (Combined) by Rs. 100 billion on a monthly average, the homogenization of the tax structure has resulted in revenue loss of certain states. Therefore, to compensate and to meet their plan/ non-plan expenditure obligations, the states are raising money through the money and capital markets despite meeting FRBM mandates critical for India's sovereign ratings. The combined public debt (Center + States) now stands at 73.4% of the GDP – one of the highest among peers.

Post the 14th Finance Commission recommendations, while the Center has consolidated its finances through devolution – the States are sadly operating in a different spectrum due to ongoing regional elections and political priorities. States, on a collective basis have raised over Rs. 24,900 billion, as on Q1 FY19. However, the same political pursuits have become their nemesis as states are often times unable to execute projects because of lack of public support. Also, the private sector, which is dealing with its own set of problems pertaining to access to finance and capacity underutilization - is unwilling/ unable to participate in Government sponsored projects as anticipated.

These bottlenecks leads to a situation where the corpus of money raised is often times not deployed. This non-deployed cash is then either fixed deposited in banks (FDs) or invested in short term (money market) instruments so that turnover is quick and easy. However, with interest rates going up and the crowding out effect due to oversupply, long term SDLs are experiencing spike in yields so much so that differential between money raised and money invested is currently 183 bps, highest since the volatile environment of FY11. As compared to Central Government's 10 Year GSecs, the differential for State SDLs is over 35 bps, making them very expensive. This is causing a 'Negative Carry' situation for the States, which either have to raise additional debt to finance their interest servicing or use their revenue expenditure, cutting down on critical public projects. Using RBI data, we reckon that as on Q1 FY19, the Negative Carry obligation is over Rs. 40 billion for States.

  14-Day (ITBs) (in Rs. billion) (in Rs. billion) Total (in Rs. billion) 91 days T-bill (% yield) WA Yield of SDLs (% yield) Yield differential (Raised and Invested)
FY11 1000 200 1200 6 8.39 -2.39
FY12 1150 150 1300 8.39 8.79 -0.4
FY13 1300 300 1600 8.16 8.84 -0.68
FY14 800 400 1200 8.67 9.18 -0.51
FY15 842 394 1236 8.45 8.58 -0.13
FY16 1,206 383 1589 7.37 8.28 -0.91
FY17 1,561 366 1927 6.39 7.48 -1.09
FY18 1,509 621 2130 6.15 7.67 -1.52
FY19* 1162 1220 2382 6.52 8.35 -1.83

Source: RBI; Acuité Research

  Gross Fiscal Deficit % of GDP State Securities Outstanding (In Billion Rupees)
FY11 1603 2.12 6,059
FY12 1717 1.97 7,425
FY13 1981 1.99 8,970
FY14 2523 2.25 10,619
FY15 3346 2.68 12,755
FY16 4200 3.05 16,314
FY17 5359 3.51 20,893
FY18 5167 3.08 24,288
FY19* 4865 2.6 24,954

Source: RBI; Acuité Research; *Budgeted Estimate (BE)