Shyamala Gopinath: Sub-national fiscal reforms and debt management -
Indian experience
Paper by Ms Shyamala Gopinath, Deputy Governor of the Reserve Bank of India, presented
at the workshop on "Sub-national Fiscal Reform and Debt Management", organised by the
Economic Policy and Debt Department, World Bank, Washington, 29 April 2009.
Assistance provided by Sanjay Hansda and Arghya Mitra in preparation of the paper is gratefully acknowledged.
* * *
It gives me great pleasure to be here amongst you and address the World Bank Sub-national
Fiscal Reform and Debt Management Forum. There is more than one reason on my part to
accept this invitation, but more importantly, to share with you the turnaround story at the
subnational level in India. The relevance of fiscal reforms and creation of fiscal space even at the
sub-national level can hardly be over-emphasised in the context of the on-going slowdown
the world over. Indeed, contrary to the general perceptions, we find in India that even the
sub-national authorities have important counter-cyclical role to play. Interestingly, the
Reserve Bank of India as the debt manager of Governments - federal and provincial - has
all through been closely associated with the task of putting in place a reformed fiscal
architecture in the country. Let me now share with you the details, which run into eight
sections, the first being the Constitutional position of the sub-national Governments. In the
absence of firm data on local bodies (the third tier of government in India), the analysis is
confined to the level of provincial governments.
I. Constitutional provisions and debt management
The Constitution of India has adopted a federal system of polity and governance, originally
envisaging a two-tier structure: Central (i.e., federal) Government and State (i.e., provincial)
Governments. With the Constitution (73rd and 74th) Amendment Acts, 1992, Local
SelfGovernment Institutions (LSGIs), i.e., rural and urban local bodies have been accorded
constitutional status as the third-tier of Government. The Constitution provides for
preparation of annual budgets and borrowings by the Centre, respectively, under Articles 112
and 292 and by the States under Articles 202 and 293.
The Constitution assigns important responsibilities to the States in many sectors such as
agricultural development, infrastructure, poverty alleviation, water supply and irrigation,
public order, public health and sanitation. States have also concurrent jurisdiction in areas
like education, electricity, economic and social planning and family planning. In addition to
provision of general administration, State Governments thus provide various social and
economic services and also transfer resources to the third tier of government - rural and
urban local bodies such as municipalities. In keeping with larger responsibilities assigned to
the States, their expenditure accounts for a substantial portion of the Government sector
expenditure (Centre plus States) in India and stands higher than in several other countries
such as Australia, Denmark, Argentina, USA and Germany (World Bank, 2005). While the
State Governments collect about one-third of the total Government sector receipt, they incur
more than three-fourths of the total expenditure on social services and more than half of that
on economic services.
The States' ability to undertake and perform the developmental functions adequately and
effectively is critically predicated on their fiscal position, which is a function of their own
efforts in generating resources - tax, non-tax receipts and borrowings as also the resource
transfer from the Central Government.
Sub-national borrowings
Article 293 of the Indian Constitution imposes certain restrictions on the borrowings by State
Governments. The Article stipulates that a State may not, without the consent of the
Government of India, raise any borrowings if it has any loan outstanding, which is repayable
to the Government of India. Furthermore, under the Constitution, State governments, unlike
the Centre, cannot borrow externally. The Centre plays the role of an intermediary in the
transfer of external borrowings to States. Because of these controls exercised by the Centre,
there is not much scope for fiscal profligacy at the State level and accordingly, there have
been no instance of bankruptcy by any State Government. This also represents the largely
unitary structure of the Indian federal polity despite the significantly important Constitutional
roles that have been assigned to the sub-national Governments.
The major heads of borrowings by States include: (i) open market borrowings, (ii) special
securities issued to National Small Savings Fund (NSSF), (iii) loans from banks and financial
institutions (negotiated loans), (iv) loans from the Centre, (v) State Provident Funds, (vi)
deposits and advances and (vii) reserve funds.
Loans from Centre
"Loans from the Centre", which used to be a major source of State finances have since lost
its significance.
Special Securities issued to National Small Savings Fund (NSSF)
The Central Government has set up the NSSF, which is akin to a Special Purpose Vehicle
(SPV) providing an autonomous source of finance for the Governments. It mobilises small
savings through post offices and banks and lends against special non-tradable securities
issued by the States and the Centre as per the proportion fixed by the latter. The loans have
a maturity of 25 years with an initial moratorium of five years in the repayment of principal.
One-twentieth of the amount is repaid every year beginning from the sixth year. The special
securities currently carry a rate of interest of 9.5%, as fixed by the Centre, resulting in a
spread of around 1.5% for the Centre. While repayments to the NSSF are generally made
out of fresh accretion, net outflows since 2007-08 have exposed the NSSF to ALM
mismatches.
Open market borrowings
The market-borrowing programme of the State Governments (as also borrowings by way of
negotiated loans and Central loans) is finalised by the Government of India and the Planning
Commission, keeping in view the provisions of Article 293(3) of the Constitution of India.
Once the Government of India indicates, generally at the beginning of the fiscal, the size of
State-wise net allocation of market borrowings to the Reserve Bank, the Bank decides on the
timing and volume of issues, taking into account the market and liquidity conditions and the
cash needs of the States.
Debt management in 1990s
In terms of the Reserve Bank of India Act, 1934, the Bank acts as the fiscal agent and the
debt manager to the State Governments by way of mutual agreement. Accordingly, the RBI
is the banker to 26 States while it is the debt manager to all the 28 States. During the 1990s,
the Reserve Bank used to complete the combined borrowing programme of all the States
generally in two or more tranches through issue of bonds with a pre-determined coupon and
pre-notified amounts for each State (Traditional Tranche Method). High statutory pre-emption
in the form of statutory liquidity ratio (SLR) and the small size of State Government
borrowings ensured the success of these primary issues.
In 1997, State Governments were given the option to enter the market individually to raise
resources using the tap method or the auction method. In 1999, States began to adopt the
auction method and some States were able to mobilise loans at competitive rates, whereas
other States had to pay higher rates. The spreads in tap tranches were subsequently raised
to around 50 basis points in 2001-02 from 25 basis points earlier with the introduction of
Umbrella Tap Tranche for a total targeted amount at a predetermined coupon. The tap used
to be normally kept open for 1-3 days. With the deterioration in the State fisc and defaults in
State guaranteed securities, the spread over secondary market yield of Central Government
security increased steadily. The market seemed to have ceased to differentiate amongst
States in terms of their fiscal performance. The share of market borrowings by auctions
declined from 15.0 per cent during 2001-02 to 2.3 per cent in 2004-05 and the Reserve Bank
had to play an active role in convincing some of the leading players to subscribe to State
Government securities.
II. Fiscal decline of the states in late 1980s
During the 1970s and the first half of the 1980s, States had a relatively healthy fiscal
position. The buoyant growth in States taxes particularly sales tax contributed to a surplus in
the revenue account between the mid-1970s and the mid-1980s. Although the States
slashed their investment activities faced with revenue deficit from 1987-88, their debt and
debt servicing burden soared with the high cost borrowing financing current expenditure
amidst growing fiscal imbalances during 1986-87 to 1997-98. Fiscal imbalances worsened
after 1998-99 following a sizeable pay hike of the employees in sequel to the implementation
of the Fifth Pay Commission's recommendations at the State level. States faced mounting
pension burden which in case of many States increased at a faster rate than salaries.
Interest burden also grew steadily warranting increasing borrowings to bridge the GFD. The
GFD of States deteriorated sharply from 2.9 per cent in 1997-98 to 4.6 per cent in 1999-2000
before declining marginally to 4.4 per cent in 2003-04. By 2003-04, the aggregate liabilities of
States peaked at 33.2 percent of GDP from 20.9 per cent in 1996-97. The burgeoning fiscal
gap fed on itself as the ratio of interest payments to revenue receipts of States deteriorated
sharply from 13.0 per cent in 1990-91 to 26.0 per cent in 2003-04.
The structural imbalance in State finances stemmed from their limited resource base
vis-àvis growing expenditure. The narrow tax base of the States with greater reliance on indirect
taxes such as sales tax and the lack of harmonised inter-State tax structure allowed
distortions and rigidities to emerge in late 1980s. The States' own tax revenue which
financed 32.2% of the total expenditure in 1980s has shown only a marginal rise to 34.5% in
1990s. The internal resource mobilisation by the States was further constrained by stagnant
user charges as also the fact that the State PSUs such as the State Electricity Boards
(SEBs) and State Transport Undertakings were running into losses. Given the relatively
higher responsibility for the States for social and economic development, the resulting fiscal
gap is financed, among others, by vertical resource transfer from the Centre to the States.
However, the resource flow from the Centre decelerated from 15.2% in 1980s to 14.5% in
1990s following the fiscal reforms initiated by the Centre. The deceleration in transfers
emerged despite an increase in the proportion of tax transfers recommended by various
Finance Commissions. This reflected the low level of buoyancy in both income tax and union
excise duties, the then two components of shareable taxes with States.
III. Sub-national fiscal reforms
Reflecting the fiscal stress, the expenditure for developmental activities, which are directly
related to growth, has suffered; on the other hand, expenditure on non-developmental
purposes, largely committed, has witnessed a steady rise. Fiscal adjustment based
predominantly on expenditure reduction may have adverse implications for growth,
particularly when government expenditure in India is lower than that in the OECD countries.
It was felt that fiscal strategy based on revenue maximisation could provide necessary
flexibility to the pattern of expenditure. Thus, sub-national fiscal adjustment started in late
1990s as follows, motivated, among others, by the reform-linked assistance (i) from the
Centre as part of the Medium-Term Fiscal Reform Programme in line with the Eleventh
Finance Commission and (ii) from the multilateral agencies.
(i) Tax reforms
States initiated several measures towards enhancement/restructuring of the taxes within their
fold, such as, land revenue, vehicle tax, entertainment tax, sales tax, electricity duty, tax on
trades and professional tax. It was recognised that competitive sales tax reductions for
attracting investment led to revenue losses without commensurate gains. With a view to
harmonising inter-State taxes and ultimately switch over to State-level value added tax
(VAT), States initially introduced uniform floor rate during 2000 before finally switching over
to the Value Added Tax (VAT) in lieu of sales tax between April 2005 and January 2008,
which has been an unqualified success in raising the tax revenue for the States.
(ii) Non-tax measures
States also undertook measures to enhance non-tax revenues by reviewing/rationalising the
royalties payable to them, including those on major and minor minerals, forestry and wildlife,
revision of tuition fees, medical fees, irrigation water rates and tariffs on urban water supply.
The issue of user charges since not in commensurate with the cost of public services
continues to be a concern.
(iii) Expenditure management
The State Governments' measures to contain expenditure, inter alia, include restrictions on
fresh recruitment/creation of new posts, review of manpower requirements and cut in
establishment expenses and reduction in non-merit subsidies through better targeting.
(iv) Public sector restructuring
Several States have shown interest in undertaking a comprehensive review of the functioning
of the State Public Sector Undertakings (SPSUs), including the possibility of closing down of
non-viable units after providing for suitable safety-nets to the employees including VRS.
States encouraged private sector participation in the transport and power generation sectors,
set up the State Electricity Regulatory Commission (SERC) and pursued with unbundling or
corporatisation of the SEBs. One of the major tasks entrusted to the SERC is to rationalise
tariff rates. Further, the States have signed Memorandum of Understanding (MoU) with the
Union Ministry of Power to undertake reforms in a time-bound manner.
(v) Institutional reforms
Faced with mounting deficits and market fatigue in States' borrowings, States embarked on a
rule-based pursuit of fiscal reforms by enacting the fiscal responsibility legislation (FRL), first
by Karnataka (2002) and followed by Kerala, Punjab and Tamil Nadu (all in 2003). Uttar
Pradesh enacted FRL in 2004. The enactment of FRL was incentivised by the Twelfth
Finance Commission (TFC) and all but two States have enacted FRLs by May 2007.
Following the recommendations of the Core Group on Voluntary Disclosure Norms for State
Governments (2001), States are being sensitised to the principle of transparency in
Government operations so as to ensure macro fiscal sustainability and fiscal rectitude. States
have since enhanced transparency in State budgets. Some of the States also provide details
on outstanding guarantees. In addition, a few States have started disseminating information
on consolidated budgetary position, which are inclusive of off-budget borrowings.
IV. Finance Commissions and state finances
Under article 280 of the Constitution, the President of India appoints a Finance Commission
every five years. The Commission is charged with making recommendations to the President
on the distribution of the taxes between the Centre and the States and the consequent
distribution among the States themselves. It also recommends grants in aid to States and
suggest measures to strengthen the functioning of the third tier governments comprising of
Panchayati Raj (for rural areas) and Municipal bodies (for urban areas).
11th Finance Commission
In pursuance of the recommendations of the Eleventh Finance Commission (EFC), the
Central Government set up an Incentive Fund for State fiscal reforms. Each State was given
the target of a minimum improvement of 5% in the revenue deficit as a proportion of their
revenue receipt each year till 2004-05. For States with a revenue surplus, 3% improvement
in the balance in the current revenue was required for release of funds under this facility.
Accordingly, several State Governments drew up Medium-Term Fiscal Reforms Programme
(MTFRP) and entered into MoUs with the Union Ministry of Finance. The MTFRP of States
covered various areas such as fiscal consolidation, public sector enterprises reform,
power/irrigation sector reforms and fiscal transparency.
12th Finance Commission
The subsequent Twelfth Finance Commission (TFC) felt that it would be appropriate for the
States to take advantage of the prevailing market rates and avoid the spread charged by the
Centre on the assistance provided by it. The pattern of Central assistance included loan as a
major element in respect of general category States, which was implicitly funded from
borrowings by the Centre and hence, the terms of loans extended to the States reflected the
Centre's cost of borrowings. The TFC, therefore, recommended that the Central Government
should not act as an intermediary for future lending and allow the States to approach the
market directly. If some fiscally weak States were unable to raise funds from the market, the
Centre could borrow for the purpose of on-lending to such States, but the interest rates
should remain aligned to the marginal cost of borrowing for the Centre. This approach was
accepted by the Central Government, in principle, to be implemented in phases, in
consultation with the Reserve Bank.
Second, the TFC recommended back-to-back transfer of external assistance to the States
from the Centre with the States having to bear full exchange rate risk. Third, the TFC
recommended a fiscal restructuring plan based on the enactment of fiscal responsibility
inter
legislation, alia, including (i) elimination of revenue deficit (RD) by 2008-09 and (ii)
containment of gross fiscal deficit (GFD) to 3.0 per cent of GSDP. If the States are able to
fulfil these requirements, they would be entitled to debt relief including debt write-off in
respect of Central loans.
Implementation of 12th Finance Commission's recommendations
In order to operationalise the new arrangements, the Government of India constituted a
Technical Group under my chairmanship, which submitted its report in December 2005 and
made several recommendations. Accordingly, there has been progress in adoption of the
auction method for borrowing by the States. In addition, State Development Loans (SDLs)
were made eligible for repo transactions under the liquidity adjustment facility of the RBI in
April 2007 and it has been decided to introduce the non-competitive bidding facility in respect
of the primary auctions of SDLs.
The Central Government, on its part, initiated several measures to ease the debt burden of
States: (i) the Debt Swap Scheme (2002-03 to 2004-05), (ii) Debt Consolidation and Relief
Facility (DCRF) (effective fiscal 2005-06) that allowed rescheduling of central loans at a
reduced rate of interest of 7.5 per cent and debt waiver (subject to enactment of FRL and
adherence to revenue deficit reduction targets) and (iii) reduction of interest rate on securities
issued to NSSF during 1999-2000 to 2001-02 carrying interest rate of 11.0-13.5 per cent to
10.5 per cent (effective fiscal 2007-08). Further, in accordance with the decision of the
National Development Council, the obligatory share of the States in the NSSF has been
reduced to 80 per cent from 2007-08.
As regards borrowings from banks and financial institutions (negotiated loans), it is our view
that such borrowings, negotiated by States on a bilateral basis with lenders, overlap with
open market borrowings as the lenders belong to the same set of market participants. The
Reserve Bank is the debt manager for all the 28 State Governments by entering into
voluntary agreement with them and the States should, therefore, confine their banking
requirements with the Reserve Bank and not borrow from other banks.
Consolidated Sinking Fund
At the request of the State Governments, the Reserve Bank had prepared a model
Consolidated Sinking Fund (CSF) Scheme and circulated it amongst them for adoption /
consideration in 1999. The Twelfth Finance Commission had recommended that the CSF
may cover repayments in respect of all the loans of the State Governments (and not just
open market borrowings). Against this backdrop, the Reserve Bank circulated a revised
model scheme of CSF amongst the State Governments in May 2006 and of the 18 States
that have set up CSF, 14 States adopted the revised CSF scheme. As at end-March 2009,
the outstanding balance of the State Governments in CSF is Rs.240 billion accounting for
about 1.5 per cent of the outstanding liabilities of the State Governments.
Prepayment of debt
The upsurge in the surplus cash balances of the State Governments since the middle of
2004-05, in sharp contrast to the liquidity pressures witnessed in the earlier period, posed
newer challenges to the financial and cash management of the State Governments. In the
context of build up of cash balances which involve a negative carry, a few States proposed to
utilise their surplus cash to pre-pay a part of their outstanding open market debt. Accordingly,
the RBI conducted two rounds of buyback auctions in respect of two States in 2006-07.
During 2007-08, buy-back of securities was carried out for a State using the anonymous
electronic trading (NDS-OM) platform.
Thirteenth Finance Commission
The Thirteenth Finance Commission (ThFC) since constituted in November 2007 is expected
to submit its report by October 2009. Its recommendations would be applicable for five years
(2010-11 to 2014-15). The Commission would make recommendations on the distribution of
the taxes between the Centre and the States and among the States, grants in aid to States,
and suggest measures to strengthen the functioning of the third tier governments. The ThFC
will also consider, inter alia, the impact of the proposed implementation of Goods and
Services Tax (GST), the need to improve the quality of public expenditure and the need to
manage ecology, environment and changed climate consistent with sustainable
development. The Commission shall review the state of the finances of the Union and the
States, and suggest measures for maintaining a stable and sustainable fiscal environment
consistent with equitable growth. The Commission may also review the present
arrangements as regards financing of Disaster Management with reference to the National
Calamity Contingency Fund and the Calamity Relief Fund and make appropriate
recommendations thereon. The ThFC may also suggest a roadmap for 2010 to 2015 with a
view to maintaining the gains of fiscal consolidation after bringing the liabilities of the Central
Government on the deficit targets. It is expected that the ThFC, like its predecessors, would
do justice to the issues related to vertical and horizontal equity even as taking the process of
fiscal consolidation further.
State Finance Commission
The Constitution (73rd and 74th) amendment Acts, 1993 have respectively, accorded
constitutional status to rural and urban local bodies as the third tier of Government. The
Amendments provide for constitution of State Finance Commissions every five years.
Following the recommendations of the State Finance Commissions (SFCs) and taking into
account the devolutions made by the Central Finance Commission (CFC), the State
Governments are required to devolve resources to their local bodies. Not all States have
constituted SFCs. and a fewer States have submitted action taken reports (ATRs) on the
recommendations made by the SFCs as noted by the Twelfth (Central) Finance Commission
(TwFC). The TwFC, inter alia, recommended that SFCs should follow a normative approach
in the assessment of revenues and expenditure in order to arrive at the gap that may be
considered by the CFC and that the principal recommendations of the SFCs may be
accepted without modification as in the case of CFC.
V. Role of the Reserve Bank of India in sub-national finances
The RBI has, over the years, closely interacted with the State Governments in its
developmental role - particularly in areas of development of agriculture, and small industries.
The RBI was specifically entrusted with an important promotional role, since its inception, of
financing agricultural operations and marketing of crops. In fact, the Agricultural Credit
Department was created simultaneously with the establishment of the RBI in 1935.
Study of State Finances
The Reserve Bank prepares and publishes an annual Study on the State Government
Finances. This is a unique study since it compiles, consolidates and analyses detailed data
on the budgets of all the State Governments. It also documents the policy initiatives on State
finances and debt management by the State Governments, the Government of India and the
Reserve Bank. The study has been well received by policy makers and academicians, both
in India and abroad, and is an important reference document.
Model fiscal responsibility legislation
The RBI played a facilitating role in the States' endeavour for rule-based fiscal reforms by
providing the Secretariat support to a group of State Finance Secretaries for preparing a
model fiscal responsibility legislation for the States. The final report was submitted to the
Reserve Bank in January 2005. The Group recommended that the model legislation would
generally follow the pattern of the Central FRBM Act, and build upon the State fiscal
responsibility legislations already enacted. The Group also took into account the international
best practices available in the area as well as the recommendations of the various
committees on fiscal transparency and on the issues related to voluntary disclosure of
information by the State Governments. Various dimensions of the fiscal legislative
framework, such as, the choice of targets, the road map, independent evaluation criteria,
prioritisation of capital expenditure, treatment of contingent liabilities including guarantees
and computation of pension liabilities were deliberated upon to arrive at a consensus.
State Finance Secretaries Conference
Clearly, the Reserve Bank has gone beyond its statutorily mandated obligations and has
provided the platform for interface between the RBI and the State Governments based on
mutual trust on issues related to State finances where the other stakeholders - including
representatives from the Government of India, Comptroller and Auditor General and the
Planning Commission - are also invited to participate in the Conference. There are
occasions when fiscal experts, leading commercial bankers and representatives of credit
rating agencies were also invited to participate and contribute to the specific issues on the
agenda. Since 1997, 21 such conferences have been held and decisions have been arrived
at, in a consensual manner, on many critical issues such as revisions in limits on Ways and
Means advances and Overdraft Regulation Scheme, adoption of auction method for market
borrowing, setting up of Consolidated Sinking Fund, ceiling on guarantees and establishment
of Guarantee Redemption Fund, disclosure and transparency in budget-making, and model
fiscal responsibility legislation at the State level.
Standing Technical Committee on States' borrowings
The Bank's Annual Policy Statement for 2006-07 proposed to constitute a Standing
Technical Committee (STC) under the aegis of the State Finance Secretaries Conference
with representation from the Central and State Governments and the Reserve Bank to advise
on the wide-ranging issues relating to the borrowing programmes of Central and State
Governments through a consensual and cooperative approach. The STC was, accordingly,
constituted in December 2006 with the concurrence of the Government of India and in
consultation with States. All States, the Central Government and the Reserve Bank are
members of the Committee.
VI. State Government Guarantees and fiscal risk management
Against the imperative of infrastructural development on the one hand and resource
constraint on the other, the States resorted to provision of guarantees mainly to third tier
subnational entities and State level public sector (but also private sector) bodies, to promote
capital formation for economic development without regard to fiscal capacity for debt
servicing in the event of devolvement of guarantees on State Governments.
The Reserve Bank has sensitized the States about the fiscal risk associated with such
guarantees, need for transparency with regard to the guarantee policies and the magnitude
of guarantees. The Reserve Bank provided the forum in the form of State Finance
Secretaries Conference where the issues related to guarantees were discussed. Further, the
Reserve Bank provided the technical expertise and provided the Secretariat to the various
Groups on State Guarantees. Pursuant to the recommendations of a Technical Committee,
several States have since fixed a ceiling on guarantees to be issued by them. Further, a
Group of State Finance Secretaries on the Fiscal Risk on State Government Guarantees
(2002) underlined the importance of according appropriate risk weights in respect of
devolvement of guarantees and suggested estimation of risk weighted guarantees so as to
make adequate budgetary provisions for honouring these guarantees once they devolve on
the States. Since 2003, the Reserve Bank has been also organising workshops on the
evaluation of fiscal risks of guarantees for the benefit of State Government officials. The
Report of the Fiscal Responsibility Legislation at the State Level (2005) recommended fixing
a limit on annual incremental risk-weighted guarantees in relation to their GSDP/total
revenue receipts. Many States have incorporated this recommendation in their FRL although
this was not mandated by the TwFC for receiving debt relief. Consequent to the improvement
of the fiscal position of States, the record of honouring of guarantees by the State
Governments has significantly improved.
Guarantee Redemption Fund
The Reserve Bank, in its capacity as a regulator of banks and financial institutions, issued a
circular in 2003 to the effect that they should exercise due diligence and proper appraisal to
ensure project viability, irrespective of the provision of State Government guarantees. The
Reserve Bank also circulated a draft scheme on Guarantee Redemption Fund (GRF)
amongst the State Governments for voluntary adoption. As on March 31, 2009 the aggregate
investments of the nine State Governments that have set up the GRF amounted to Rs.30.4
billion.
VII. Debt management in an era of fiscal consolidation
With the implementation of the TwFC's recommendations, the year 2005-06 marked a
watershed in the evolution of State finances and debt management. During 2005-06, 48.5
per cent of the market borrowings were raised through the auction route as compared with
2.3 per cent in 2004-05. The moderation in fiscal imbalances and enactment of fiscal
responsibility legislation facilitated the smooth transition to the conduct of entire open market
borrowings by the auction route since 2006-07 as proposed by the Reserve Bank in its
Annual Policy Statement 2006-07. This was notwithstanding the sharp increase in the net
market borrowings from 0.3 per cent of GDP in 2006-07 to 1.9 per cent of GDP in 2008-09.
Reflecting the maturity profile of State Governments as also the timing of issuances, the
weighted average cost of States' borrowings was marginally higher than that of the cost of
borrowings of the Centre. The spread over the Central Government Securities has declined
from 34 basis points in 2004-05 to 16 basis points in 2008-09 (Table).
The interest rates on market borrowings continued to remain lower than 9.5 per cent charged
for borrowings from the NSSF. The shift in borrowings from the NSSF and from the Centre to
market borrowings has reduced the weighted average cost of borrowings of State
Governments and at the same time, improved their maneuverability on the desired quantum
of borrowings.
States' market borrowings have been by way of plain vanilla fixed coupon securities
denominated in domestic currency which have several advantages. This has accorded
certainty to the budgetary expenditure and reduced balance sheet risks. The uncertainties in
the cost of borrowings arising from the frequent resetting of interest rates that are associated
with floating rate bonds are absent.
The maturity of State Government security is usually 10 years although securities of 11-13
years have also been issued. The longish maturity of State Governments has protected the
State Government balance sheet from refinancing risk. Since the 10-year