India's state borrowers are crowding out cash-strapped private firms

Mumbai

INDIAN companies struggling against the Covid-19 pandemic and a domestic credit crunch are facing another obstacle: competition from state governments to sell debt.

States in Asia's third-biggest economy are planning to crank up bond sales by 18.2 per cent this quarter from a year earlier to make up for a decline in tax revenue due to an economic slowdown. They usually have lower credit risks than companies, and are offering higher yields than before, which could entice investors. The corporate bond market was already suffering, prompting the central bank on Friday to again inject more money into it.

"Demand for longer tenor corporate bonds from insurers and pension funds is expected to fall as they shift allocations to state bonds after the recent surge in yields," said Manoj Jaju, chief investment officer at Bharti AXA General Insurance Co. "We too will have a bias towards state bonds over corporate debt now."

India isn't alone in seeing massive bond sales by governments as authorities across the world come up with stimulus steps. Weakening demand for company debt in India will put added pressure on borrowers already suffering from the world's biggest lockdown, a probable recession and a credit crunch that started in 2018. It also risks diluting the impact of the central bank's approximately US$50 billion unconventional cash steps to support the credit market.

The Reserve Bank of India on Friday said it will inject 500 billion rupees (S$9.3 billion) into the corporate bond market in a new round of targeted long-term repo operations. At least half of the funds made available to banks through the facility should go to lower-rated firms, including shadow lenders and micro-financial institutions. Yields on corporate bonds slid sharply after the steps.

But recent cases show how state debt may be more appealing than company securities, even with the extra policy support. Maharashtra state, home to Mumbai, is a case in point. It auctioned 10-year debt on April 7 with an annualised yield of 7.98 per cent, the highest for that tenor since January last year. The latest rate was 44 basis points more than the yield on similar maturity AAA corporate notes. On the same day, REC Ltd, a state-owned financial firm, scrapped plans to sell notes because market participants demanded higher yields.

State bonds are also attractive because they have better trading liquidity in the secondary market compared with corporate securities, said Mr Jaju at Bharti AXA. The state notes are accepted as collateral at the central bank's repurchase auctions, unlike corporate bonds, providing an added incentive for investors, he said.

At the same time, the higher yields on state bonds are a reflection of their budget difficulties. States' spending requirements are likely to shoot up this financial year on account of Covid-19, especially in health and welfare, according to a report from ICICI Securities Primary Dealership Ltd.

As tax revenues fall, though, the trend towards more bond issuance seems certain at any rate.

Other states have also sold securities with high yields recently. Kerala state offered 10-year notes on April 7 at an annualised yield of 8.07 per cent, while West Bengal issued 2030 bonds on March 30 at 7.49 per cent. BLOOMBERG