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Harish Damodaran

New Delhi , Oct. 31

THE Finance Ministry's debt-swap scheme, originally meant to help State Governments prepay their high cost Central loans, is turning out to be a huge interest cost saver for the Centre as well. During the current fiscal alone, the scheme is expected to confer interest savings of over Rs 1,200 crore to the Centre, a figure that may touch Rs 4,500 crore from 2005-06 onwards.

To see how, one needs to first consider the way the scheme has been structured, involving some truly ingenious financial engineering. The scheme basically allows the States to retire roughly Rs 1,00,000-crore loans from the Centre bearing coupons in excess of 13 per cent, by swapping these with additional market borrowings and up to 30 per cent of their net small savings proceeds at the prevailing (lower) interest rates. The whole process is to take place over a three-year period ending 2004-05.

During 2002-03, the States prepaid Central loans of Rs 13,766 crore under the scheme, of which Rs 10,000 crore was from market borrowings (allocated in addition to their normal quota) and the rest through small savings proceeds. During the current fiscal, another Rs 32,000 crore of high-cost debt has been swapped so far with additional market borrowings of Rs 23,000 crore and small savings collections of Rs 9,000 crore.

The interesting bit though relates to what the Centre has done with the monies received, manifested as additional `recoveries of loans'. On March 28, the entire first recovery instalment of Rs 13,766 crore was used to redeem a part of the 10.5 per cent interest bearing `special securities' issued in the past by the Centre to the National Small Savings Fund (NSSF). These non-marketable securities were issued against its outstanding small savings liabilities of Rs 1,76,221 crore, incurred prior to the Fund's establishment in April 1, 1999. The NSSF, in turn, re-invested the redeemed sum in special securities issued afresh by the Centre, this time at 7 per cent.

The same process has been repeated for the second loan recovery instalment of Rs 32,000 crore, which, on September 30, was first used to redeem the Centre's 10.5 per cent special securities against small savings, followed by the issue of fresh securities of equivalent face value, bearing an even lower coupon of 6 per cent.

Simply put, the debt-swap scheme has not only enabled States to replace till date nearly Rs 46,000 crore of high cost loans from the Centre with cheaper market borrowings and small savings proceeds, but has also been used by the latter to swap an equivalent amount of 10.5 per cent special securities issued to the NSSF with issue of fresh stock at 6-7 per cent. The Centre's interest cost savings on this count would work out to Rs 1,200 crore during 2003-04 alone.

Finance Ministry officials expect another Rs 13,000-14,000 crore of debt to be similarly `double-swapped' in the remaining months of the fiscal, taking the cumulative figure to Rs 60,000 crore. By the end of 2004-05, the Centre would have replaced around Rs 100,000 crore worth of its own past high-cost special securities issued to the NSSF with fresh paper bearing 400-450 basis points lower coupons. This translates into annual interest outgo savings of Rs 4,000-4,500 crore.

What's gain for States?

THE savings in interest outgo to States from the Finance Ministry's debt-swap scheme depends a lot on the extent of additional market borrowings theyare permitted to undertake for this purpose.

So far, of the nearly Rs 45,800-crore high-cost Central loans (bearing 13 per cent plus coupon) pre-paid by them, Rs 33,000 crore has been made from market borrowings at sub-6.5 per cent. The remaining Rs 12,800 crore has been swapped against their issue of special securities to the National Small Savings Fund (NSSF), for which the coupon has been fixed at 9.5 per cent during 2003-04. This is even as the Centre has been issuing similar securities to the NSSF at just 6 per cent.

Given a chance, the States would like to retire their entire Rs 1,00,000 crore 13 per cent-plus loans from the Centre, by swapping these with market borrowings at roughly half this cost. But this is something that neither the Finance Ministry nor the Reserve Bank of India (RBI) would be inclined to accept, as they believe that enhanced market borrowings by State Governments will lead to tightening of liquidity conditions.

The States may then have to retire much of the remaining Rs 54,000-odd crore of high-cost loans through the small savings route, with the Centre probably allowing them to issue special securities to the NSSF at a lower coupon. This would, however, require a further reduction in interest rates on small savings schemes, that too in an election year.

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