MUMBAI Feb 26 A move by India to make the
pricing of roughly $30 billion in debt sold each year by
individual states more market-based has met resistance from both
issuers and investors, underscoring the difficulties it faces in
deepening its bond markets.
The Reserve Bank of India (RBI) this month proposed to scrap
a 14-year-old system under which state debt is valued at a fixed
spread of a quarter-percentage point over government bonds,
though it has told Reuters the recommendation is not final.
Two auctions of state debt held since the rule was proposed,
including one on Tuesday, fell short of targets as investors,
mainly state banks, worry that they will be forced to book
losses if their holdings are subject to market pricing.
"Demand has already come down for SDLs (state development
loans). If it becomes a rule, then investors are staring at
losses on their existing portfolio," said Anindya Dasgupta, a
managing director in Mumbai at UK-based lender Barclays.
"But this is the right thing to do. Mark-to-market should be
based on traded or auctioned yields," he said.
A senior official at a large state bank said some lenders
may see mark-to-market losses of about 60 basis points on their
state bond portfolios if the rule is implemented as proposed.
"There was a bonus for investing in SDLs which won't be
there anymore," he said, declining to be identified because of
the sensitivity of the matter.
To improve demand, the RBI is considering auctions of state
bonds in which all winning bidders pay the same price, sources
familiar with the issue said.
While the old system for valuing state debt gives certainty
to issuers and investors, it raised worries among policymakers
that it did not reflect the risk of state credit, even though
the bonds carry a sovereign guarantee.
That also deterred investor interest beyond banks, which are
required to hold 23 percent of their assets in Indian government
debt, including state bonds - an arrangement that has long been
criticised for enabling heavy government borrowing while
stunting broader market development.
Indian policymakers have struggled to develop broader and
deeper credit markets that would help companies fund costly
long-term projects such as roads and power plants, and hedge
their interest rate risk.
Since taking office in September, RBI Governor Raghuram
Rajan has relaunched bond futures with a more market-friendly
design and nudged banks to shed dependency on the central bank
for liquidity by capping access to overnight funds.
However, the move to reform state bond valuations began
under his predecessor, Duvvuri Subbarao.
"The recommendations of the Committee on Financial
Benchmarks are under examination," the RBI said in an emailed
response to a query from Reuters.
Under the proposed rules, state bonds would be auctioned at
the average spread above federal debt in the previous two
auctions, aligning prices more closely to market levels.
Indian states worry that under the new system they would
have to pay substantially more to raise debt.
"We will discuss this with the Reserve Bank," a senior
finance official in Andhra Pradesh state told Reuters, also
declining to be identified. "This is a matter of concern."
In Tuesday's auction, the state of Gujarat, with an average
fiscal deficit of 2.4 percent of output over the past three
years, paid a yield of 9.75 percent, while West Bengal, with a
deficit of 3.6 percent, paid 9.85 percent.
The slight difference in yield was based on market demand,
although under both the old and proposed rules investors can
assign the same valuation to both credits for accounting
The RBI, which manages debt sales for the state and federal
governments, managed to sell only 76.5 billion rupees ($1.24
billion) of its target of at least 85.3 billion rupees worth of
state debt in Tuesday's auction.
($1 = 62.0450 Indian rupees)
(Additional reporting by Subhadip Sircar and Archana Narayanan;
Editing by Tony Munroe & Kim Coghill)