Higher Borrowing by States to Widen Yield Spread with G-sec

Context: The spread between yields on the 10-year state development loans (SDL) and the Centre’s G-sec (government securities) widened to a two-year high. 

G-sec Market in India: Statistics

• According to data compiled by rating agency ICRA, The yield spread widened to 53 basis points (bps)  due to the large supply of state bonds during the last quarter of the current financial year.
  • The last time the yield spread widened above 50 bps was in January 2022.
  • The widening of yield spread indicates a growing disparity in borrowing costs between states and the central government.
  • The higher borrowing is expected to increase borrowing costs for states compared with the Centre.
• Projection: A record borrowing of Rs 4.13 lakh crore has been proposed by states and UTs in the last quarter of FY23 
  • This will be over 37.4 percent higher year-on-year.
  • The yield spread between the 10-year state governments’ loans and the benchmark 10-year G-sec is expected to widen further to about 60 bps. 

About G-Sec (Government Securities)

• Definition: G-Sec is a tradable instrument issued by the Central Government to raise money from the public to finance the fiscal deficit. 
• Manager: The RBI manages these G-Sec loans. 
• Eligible Security: G-Sec are eligible securities for the RBI under LAF Repo operations. 
• Limit: The Centre can borrow up to a set limit under the FRBM Act. 
  • This limit has been fixed at 5% of the Gross Domestic Product (GDP). 
• Retail Direct Scheme: It permits investment by retail investors in the Government Securities market through an online portal. 

What is the Yield of the Bond?

• Definition: Bond yield is the return an investor realizes on a bond. When an investor buys a bond from the secondary market, the expected returns depend on the price paid to purchase the bond from the secondary market, at a discount or at a premium over the face value. 
• Formula:  Bond Yield = Coupon Amount/Price 
• Relation: Bond Yield and Price are inversely related. 
• Spread: Bond Spread or Yield Spread, refers to the difference in the yield on two different bonds or two classes of bonds.

What are State Development Loans?

• Definition: State Development Loans (SDL) is a bond issued by state governments to fund their fiscal deficit.
• Manager: The RBI manages these SDL loans. 
• Rate: The coupon rates on SDLs are marginally higher than those of GOI-Secs.  
• Eligible Security: State Development Loans are eligible securities for the RBI under LAF Repo operations. 
• Limit: Each state can borrow up to a set limit under Article 293(3) of the Constitution. 
  • This limit has been fixed under the FRBM Act to 3% of their Gross State Domestic Product (GSDP). 
  • Fiscal Responsibility and Budget Management Act, 2003 establishes targets for the Fiscal Deficit of the Centre and States with a view to establishing fiscal discipline. 

Source: Indian Express

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