As States issue more debt, finding the investors who will subscribe to the issue will require expanding the current pool of investors and making the investment more lucrative.
While there have been many deliberations in these pages on the growing amount of debt that the various tiers of the government (Centre and States) will have to raise, little discussion has gone into who they will raise the funds from. It is left to the all-encompassing term: ‘market borrowing’. We deep-dive to see who constitutes this market and what policy implications arise.
Every September, the Reserve Bank of India (RBI) releases a treasure trove of data: Handbook of Statistics on the Indian Economy. While there are many aspects of interest in this data release, we will specifically focus on tables 113 and 114. The former details the “Combined Liabilities of Central and State Governments” and the latter, “Ownership of Central and State Government Securities”. These annual data releases of RBI are compiled in the Database on Indian Economy (DBIE) which has data going back many decades.
While there is significant uncertainty on the shock to GDP in FY2021 (and a possible fast rebound in FY2022 – with some estimates looking at a 19% nominal growth), for sake of simplicity, it is useful to keep the FY2020 estimated GDP in mind: approx. Rs 200 trillion. This will help us put the debt numbers in perspective.
Table 113, in the latest release, informs us that the total liabilities of the Centre, at the end of FY2020, is estimated to be Rs 102.6 trillion (out of which Rs 97.5 trillion is owed domestically and only Rs 5.1 trillion is foreign). The States borrow only domestically: their total outstanding is Rs 52.5 trillion. Between the Centre and States, hence, total domestic liabilities are Rs 150.0 trillion. These liabilities also include ‘reserve funds’, ‘deposits and advances’, and ‘contingency fund’ of the Centre and State governments. This puts aggregate domestic liabilities of the governments combined at ~75% of GDP.
Table 114 gives a break-up of ownership of Rs 102.9 trillion of securities issued by governments as at the end of FY2020: Central government securities outstanding were Rs 64.9 trillion, treasury bills amounted to Rs 5.4 trillion, and State governments had Rs 32.6 trillion of securities. Total outstanding securities of the various governments hence amounts to ~51% of GDP.
Market for government debt has changed markedly. As at the end of FY2014, outstanding securities totalled Rs 51.1 trillion, or half the current number. This comprised Rs 37.2 trillion (Centre), Rs 3.4 trillion (treasuries), and Rs 10.6 trillion (States) respectively. Growth in outstanding securities has been uneven: Centre’s outstanding went up by Rs 27.7 trillion and treasury only Rs 2.0 trillion; however, States’ outstanding rose by Rs 22.0 trillion, more than tripling their outstanding securities since FY2014. (See table 1.)
One man’s debt is another’s investment
Holding on to a security issued by a national or a sub-national government is assumed, both in theory and almost always in practice, to be risk-free. In most cases, there is a specific legal or regulatory requirement for key market participants to hold on to government securities. This takes the form of a statutory liquidity ratio (SLR) for banks and cooperative banks, and prudential guidelines for insurance companies, provident funds, etc. Note that foreign investors and RBI invest only in central government securities and practically don’t own any state government paper.
Government’s debt stock is subscribed to by a wide variety of market participants. Key holders of the overall Rs 102.9 trillion of debt, as at end of FY2020, were Scheduled Commercial Banks (Rs 40.4 trillion), insurance companies (Rs 27.0 trillion), provident funds (Rs 10.3 trillion) and RBI (Rs. 9.8 trillion). Between these entities, they held Rs 87.5 trillion, while others (mutual funds, cooperative banks, foreign investors, retail, corporate, state governments, etc.) held a collective Rs 15.4 trillion.
Since FIs and RBI don’t hold State paper, the large increase in state outstanding were picked up by four main participants: insurance companies (Rs 7.1 trillion), scheduled commercial banks (Rs. 6.1 trillion), provident funds (Rs 5.7 trillion), and cooperative banks (Rs 1.1 trillion). These participants picked up a total of Rs 20.0 trillion (or around 90% of the increased outstanding). It is pertinent to note that all increase in scheduled commercial banks holdings came from nationalized banks and regional rural banks; private banks were net sellers. (See table 2.)
As Covid-19 reduces tax revenues and stimulus increases government expenditure, increased borrowings are a natural corollary. Demand for funds will be sudden and large thereby potentially disturbing a natural equilibrium and an orderly clearing of market. To ensure that demand for funds meets supply, participation from market participants will need to increase and the pool has to widen.
Participation from key participants can increase if they get start to get higher underlying flows: more insurance premia is collected, deposit growth remains strong, employees save more, etc. Banks have seen high deposit growth; however, insurance premia has increased more in protection plans (like term covers) and there have been job losses leading to withdrawal from pension funds. In order to generate yield in a falling interest rate environment and to get higher expected returns, insurance companies and pension funds are also turning to equity markets. Regulatory requirements do not specifically require holding of state government paper – as more supply comes from there, regulations may emerge to specify such holding.
Increasing pool of participants will mean making the market more attractive or relaxing entry norms. Reduction in (or elimination of) taxes on interest or on capital gains of such securities, allowing participation by FIs or alternate investment funds (AIFs), creating ETF-structures for state government debt with market-makers to offer liquidity, etc. can be considered.
The author is with Axis Bank. Views are personal.
Originally published in The Financial Express on 9th October, 2020.