State Govt borrowings become expensive on tight liquidity:BL 241209
Banks favour short-dated papers.

The last round of borrowings through State Development Loans saw the average spreads over ten-year
sovereign papers rising to about 45 basis points.

State governments' market borrowings have become more expensive with the liquidity overhang
dissipating.The last round of borrowings through State Development Loans (SDL) saw the average spreads
over ten-year sovereign papers rising to about 45 basis points.
Banking sources said that the rise in spreads was largely on account of reduced interest in SDLs among
banks. Spreads for some States like Jammu and Kashmir were however, about 80 basis points. This was
despite the sovereign guarantee cover on the papers. States like Madhya Pradesh have raised funds at
spreads of 55 basis points or 8.45 per cent. Only in the case of some of the southern States like Kerala and
Tamil Nadu, the spreads over sovereigns were lower than the average at about 40 basis points. The lower
spreads were largely on account of better credit rating of the States, unlike the northern States that still have
arrears in debt service payments.
Despite the discriminatory perception in the financial markets, the rise in average spreads was largely on
account of the tightening liquidity conditions, on account of the external factors and the Reserve Bank of
India's aggressive sterilisation operations.
Long maturities
Besides, the bankers said that few of them were interested in having SDLs in their investment portfolios in
view of the long maturities of the loans. Although SDLs by virtue of their sovereign guarantee status are zero
risk-weighted, the papers are largely illiquid in the secondary markets, bankers said.
Typically, in a tight or anticipated tight liquidity situation, the preference tends to be more for short-dated
papers, particularly Treasury Bills. With the derisking of investments, banks have contained the average
maturity to about two years. Besides, they added, the derisking was also resorted to in view of the Basel II
compliance, where depreciation charges would be high on long-dated papers.
Consequently the only investors in SDL papers were life insurance companies, the bankers said. Insurers'
preference was also for compliance with mandated investments directives of the insurance
regulator.However, bankers said, most life insurers who are the largest investors in SDLs, have mean yield
expectations in excess of 8.5 per cent. These expectations are likely to rise in the coming months, the
bankers said, to partly offset the turndown in the equity markets.