The state governments could buy back some old papers and re-issue under the borrowing programme to increase liquidity.
The Reserve Bank of India has begun consultation with state governments and investors to understand the concerns and facilitate process for improving liquidity.
Senior public sector bank executives who attended the meeting in the middle of January in New Delhi, said two issues were in focus. One, ways to attract more investors to trade in state paper and improve liquidity. Second, states having to pay premium (offer higher coupon rate) on paper over government bonds.
These securities issued by state governments are also known as State Development Loans (SDLs). The issues are also managed and serviced by the Reserve Bank of India.
According to CRISIL’s annual book on Indian Bond market 2014, state government bond issuances grew by 17% in 2013-14 to touch Rs 2, 00,000 crore for the first time, largely in line with the growth in gross state domestic product.
The minimum liquidity is in nature of the market with investors like Provident Funds and insurance companies preferring to bonds till the maturity. They are looking at safe investment with steady stream of income and are not keen in trading in them.
Making bonds liquid
Bank treasury executives and mutual fund executives said as a step to improve liquidity, states could issue bonds with varying maturities like five year and even much long duration paper of 15 years.
At present, states continue to borrow a majority of funds through 10-year bonds. Borrowings of up to five year maturity, introduced in fiscal 2013, has miniscule share.
There is enough appetite for state development loans (SDLs) but the allocation to SDLs compared to the G-Secs is much lower in mutual funds, he said.
Also, state governments can buyback bonds which were issued earlier. This would create liquidity (market based sale and purchase transactions) in otherwise illiquid instruments.
IDBI Bank executive said for buying back, state can set aside say Rs 500 crore out of Rs 10,000 crore raised from market. It creates market, a better option that parking temporary surplus into treasury bills.
Struggle for Parity with GOI bonds
Another question that came up for discussion at meeting was higher yield that market expects state governments to pay for bonds over 10-year bonds issued by the Central government.
Those representing states showed displeasure over the premium that states have to pay over government of India bonds.
Head of treasury with SBI’s associate bank said states often feel that they end up paying premium (higher yield) due to higher perceived risks like reservations over debt repayment ability. Till date no state government has defaulted on payment of interest and principal.
Treasury executives explained that higher yield captures illiquidity in these instruments. Secondary market activities in the previously issued securities are very poor but the recently issued securities are most traded instruments, according to Clearing Corporation of India Ltd.