Government development loans: Should government development loans come with differential rates?

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By Madan Sabnavis
A question that has often been raised is whether or not all states should be able to borrow at the same rate to balance their budgets. As all State Development Loans (SDLs) are considered sovereign debts which are also referred to as SLRs, the level of finance governance does not really matter.

The states that end up borrowing at the lowest weighted average cost are the ones that borrowed the most when yields were low and not because the market favored them. Better-funded states rightly argue that their debt would be rewarded by the market if differential pricing were possible.

State governments manage different types of budgets. While some are financially savvy, others tend to be more flexible in their ways. Similarly, the quality of the budget may vary, with some focusing on capital expenditure and other productive expenditure such as education, health, agriculture, etc., while others may prefer to allocate more politically motivated subsidies.

The reason it doesn’t matter today is that there is a sovereign guarantee on all loans taken out.

Therefore, it is necessary to distinguish the debt quality of any state government based on the assessment of finances which answers the question whether or not the state has the means to repay its debt s is not supported by the concept of “sovereign”. In fact, even the withdrawal of SLR status can result in a difference in the debt collection of two states.

Another argument in support of this idea is that if municipalities are also part of the federal structure at the tertiary level, their debt does not benefit from “governmental” status. Urban Local Authorities (ULB) carry out the same development work as the State and States and also have the power to levy taxes and other charges in accordance with the Constitution. They also receive transfers from the Union and state governments for performing their duties. Yet municipal debt is not guaranteed by the states or union government and carries credit risk, just like a business. Given their weak finances, they are unable to borrow from the market which, in turn, has prevented the development of a municipal bond market. That said, there is a strong argument in favor of abolishing the sovereign status of public debt.

However, on the other hand, this may not be feasible. Firstly, there is already a large amount of outstanding government debt in the order of Rs 23 lakh crore, which will need to be reassessed once they are rated on a different scale.

Second, various state governments incur expenses that are also performed by the Center, such as grants and waivers.

Thus, ideologically, what is good for the Center cannot be bad for the States. Third, some states account for the bulk of the production of specific agricultural products that are subsidized. Removing these subsidies would mean that the whole country would be affected by supplies or prices that do not bode well.

Fourth, suppose a state is not highly rated and finds few buyers for the newspaper, then the Budget goes into overdrive. Fifth, there are already FRBM rules in place regarding the revenue deficit, budget deficit and debt levels of various states. As long as they are adhered to, there should be no concern.

Can we really say that a state that permanently manages a budget deficit of say 2% with less spending is better than a state that regularly receives 3%? Sixth, with the GST in place, the possibility of introducing new taxes or increasing tax rates is virtually ruled out. So, under these conditions, would it be fair to impose conditions when there is no control over the receipts?

Finally, the market is failing to reprice central government debt, however large it may be (which is dictated by liquidity conditions and the accommodative measures taken by the RBI).

Therefore, asking states to now pay differential rates that are already 50 to 60 basis points higher would not be fair. The point to be emphasized here is that governments are not corporations because their objective is to foster development and in order to do so they undertake several expenditures which may not be commercially sensible.

Therefore, in this thought process, FRBM rules seem to be the best solution when states are forced to operate within these limits.

The time has not yet come to introduce the concept of differential pricing.

(Views are personal)

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