Thursday, September 17, 2009


SDLs to flood the system in H2; spread over G-sec to soar 120bps+

Twelfth Finance Commission recommendations on state finances
  • The Twelfth Finance Commission (TFC) and Fiscal Responsibility Legislation (FRL) were enacted in 2002 and 2003, respectively, to guide various states achieve fiscal prudence.
  • The TFC recommended reduction of state fiscal deficit to 3% by March 31, 2009 along with the complete elimination of revenue deficit. State governments were also advised to borrow directly from the market without the central government being an intermediary.

Budgeted state expenditure management hit by crisis
  • The onset of the global housing crisis that rendered a serious blow to industries world wide tainted the pretty picture painted by FY09 budgeted estimates.
  • As per RBI’s release of revised FY09 estimates of state deficits, the consolidated fiscal deficit soared to 2.7%, with interest payments (budgeted at 14.6% of the revenue receipts for FY10) growing at 15% Y-o-Y in FY10; the interest cost of SDLs in FY10 is expected to inch up 40-50bps to 8.20-8.40% from the FY09 levels.

Budget analysis of top SDL issuers in FY09
  • Over the past two years, some of the biggest borrowers witnessed an absolute jump of over 2-3x in their fiscal deficit; Tamil Nadu’s fiscal deficit soared from INR 36 bn in FY08 to INR 118 bn in FY10.
  • Maharashtra, Tamil Nadu, and West Bengal witnessed the maximum fiscal slippage among the states under study. West Bengal is expected to post revenue deficit of 42% of its revenue receipts for FY10.
  • We anticipate the overall deficit to soar further as GSDP growth rate estimates for some states under study fail to post the budgeted performance; three out of the five states anticipate 10% annual growth in their respective GDP for FY10.

Expectations for state finances (FY10)
  • The gross fiscal deficit of state governments is expected to rise from FY09 levels by 70bps to 3.4%. The growing burden of interest payments, expected to sustain at 2% of GSDP, is budgeted to double the primary deficit to 1.4% in FY10 from the FY09RE levels.
  • The debt-GDP ratio (which had dipped from 32.7% in 2004-05 to 27.5% as per BE of 2008-09) is expected to witness a U-shaped trajectory with higher reliance on debt financing, offsetting the deleveraging (reduction in outstanding liabilites) carried out for state balance sheets since FY05.

FY10: Flurry of SDL supplies and cut-off expectations

  • Relaxation of the FRBM target for states by 0.5% of GSDP is expected to supply the market with an additional INR 210 bn worth of SDL; cumulative SDL issuance is expected at INR 1.56 tn for FY10.
  • With INR 1-1.1 tn of SDL supplies scheduled in H2FY10, we expect the spread over equivalent maturing G-sec to balloon from present levels to 125bps by December, and have further upside bias in final quarter of the FY10. In case of bear widening, with corporate bonds expected to exhibit stickiness as present levels, SDLcorporate bond spreads are also expected to shrink to 10-20bps as existing corporate spreads over G-secs remain around current levels.

Twelfth Finance Commission recommendations on state finances
  • The finance framework of states has come a long way from being only an additional limb of the complex central government finance machinery. While the Twelfth Finance Commission has been instrumental in building a budgetary balance for both the Centre and states by laying out a devolution mechanism for the shareable portion of revenue proceeds, the gradual adoption of state-specific fiscal responsibility legislations has called for larger significance of the study of state government budgets.
  • In 1997, during the maiden conference of state finance secretaries, Dr. Rangarajan, the then RBI governor, brought to light various issues that needed to be addressed for the management of state finances.
  • In an effort to provide guidance to various states to attain fiscal prudence, the TFC and FRL were enacted in 2002 and 2003, respectively. The latter is similar to Centre’s FRBM Act, catering to the expenditure management policies at the state level.

To see full report: STATE FINANCES