State bond supply to surge as rural jobs’ costs escalate

Increased burden likely to drive up states’ borrowing costs, push yields higher

- Subhana Shaikh

An increased funding burden on the states under India's revamped rural jobs guarantee scheme is expected to push up their borrowings and send bond yields higher, according to market participants.

The Viksit Bharat-Guarantee for Rozgar and Ajeevika Mission (Gramin) (VB-GRAMG) Act shifts the Centre-state funding ratio to 60:40 from the current 90:10 under the Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS).

‘The higher funding responsibility on states would increase borrowing requirements, widen the spread or yield gap between state development loans (SDLs) and government bonds, and limit any near-term softening in sovereign bond yields, which have remained elevated for most of the year, according to at least five market participants who spoke with Mint.

“Willy-nilly, states will have to borrow more. On a net basis, borrowings will rise, and that will again have implications for yields,” said Killol Pandya, head of fixed income at JM Financial Asset Management. While higher yields may initially attract investors who have stayed away back to SDLs, Pandya warned that excessive supply could eventually lead to illiquidity.

“There will be a tipping point. If everyone's limits are packed, secondary market volumes will fall, and yields will have to move higher to entice buyers,” he said, adding that interstate spreads could also widen, especially for high-population states that rely more heavily on the MGNREGS.

A rise in market borrowings and an uncertain global environment have already widened the spreads between 10-year benchmark government bonds and SDLs to 65-98 basis points in last week's auction. This is higher than the historical spreads of 30-40bps. One basis point is one-hundredth of a percentage point.