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Plan to let States enter debt markets directly

C. Shivkumar

BANGALORE, Nov. 12

THE Reserve Bank of India has initiated a proposal with State Governments for their direct entry into the financial markets for meeting their borrowing requirements.

Discussions on this proposal were held on November 3 between State Finance Secretaries, representatives of credit rating agencies and RBI officials. The purpose of these discussions was to prepare a road-map and a rating methodology for paving the way fo r the States to enter the financial markets.

Financial institutions and foreign investors in the power sector are already carrying out ratings on the States, though such ratings are outside the public domain.

Sources said the discussions centered around the methodologies to be adopted for credit rating of State Governments. Currently, few State Governments had any direct outstanding ratings.

But, whatever outstanding ratings were made, they were on the financial guarantees provided by these Governments on the borrowings by the respective special purpose vehicles floated for the purpose or for borrowings made by the respective public sector u ndertakings which included State electricity boards, State finance corporation and industrial development corporations.

Sources said that direct entry of the States would hinge on their ability to secure at least an investment grade rating from one of the credit rating agencies. Currently, direct borrowings had not been done.

Borrowings, so far, had been made on quota allocations prepared by the RBI, which floated bonds on behalf of the State Governments and apportioned them among the banks.

The proposal, sources said, would imply that some of the State undertakings such as State finance corporations, State electricity boards and State industrial development undertakings would be taken out of the purview of the statutory liquidity ratio.

This was also likely to apply to some of the direct State Government borrowings, which have so far had the benefit of securing low coupon rates on the strength of the sovereign guarantees.

No timeframe had been prescribed so far for this kind of a disintermediation. But, sources said, the next round of meetings between the RBI and the Finance Secretaries was likely to dwell on the road-map for direct entry into the markets.

One of the issues involved in direct borrowings by States was that costs would tend to vary. For instance, States which had a higher credit rating, would tend to obtain lower coupon rates and States, with lower credit ratings, would tend to have higher c oupons on their respective borrowings.

This kind of risk premiums were already present in the secondary bond markets, where States with higher risk perception had a higher yield to maturity rates as compared to lower risk States.

For instance, borrowings by Orissa had a higher risk premiums than Karnataka, which has an A+ rating by Crisil, whereas Orissa was much lower in the scale.

Sources said that as a pre-requisite for such a proposal to be implemented, a concrete methodology for ratings would also have to be in place. Currently, there was no standardised method of ratings between the two rating agencies for credit rating of Sta tes.

But the only common parameters were that both the agencies tended to give high weightage for fiscal management and financial prudence in their respective scales.

However, irrespective of the rating methodologies, sources said , both the agencies tended to bring out the ``debt carrying capacity of the States'' through their rating scales. This was now likely to become a crucial parameter for the State's entry, di rect or indirect, into the financial markets.