Photographer: Dibyangshu Sarkar/AFP via Getty Images

States Steal Thunder From India's Sovereign Debt as Yields Surge

  • Spread of about 100 basis points luring investors: Tata Asset
  • Modi government's auction of treasury bills failed Wednesday

The widening spread between yields on bonds issued by Indian federal and state governments is threatening to jeopardize Prime Minister Narendra Modi’s borrowing program.

Demand for sovereign notes has soured amid concern the central government will struggle to meet its fiscal targets as it prepares to unveil the federal budget on Monday for the year starting April 1. While that’s driven yields up, the increase is smaller than for state securities, causing their average spread to expand to about 100 basis points, from around 50 basis points in the last five years, according to Tata Asset Management Co.

Twenty-one states sold debt worth 214.5 billion rupees ($3.1 billion) at a Feb. 23 offering, the most money ever raised in a single sale, according to India Ratings and Research Pvt. In comparison, underwriters have had to rescue four auctions of sovereign notes in the last two months, and the central government Wednesday failed to sell any of the treasury bills offered at a sale for the first time since July 2013.

Shorter-maturity bonds led losses in sovereign notes on Thursday, with the yield on the 7.28 percent securities due June 2019 jumping 10 basis points to 7.82 percent. That on debt maturing in 2020 also climbed 10 basis points to 8 percent, data from central bank’s trading system show.

“The spread is attracting long-term investors to state bonds and cannibalizing demand for government notes,” said Soumyajit Niyogi, associate director at India Ratings, a unit of Fitch Ratings. “Rising issuance of state debt is also a factor.”

Negative Impact

India granted foreign investors access to state-government bonds for the first time last quarter. Investment by global funds stands at 40.6 billion rupees, data from the National Securities Depository Ltd. show, against a current cap of 70 billion rupees.

Working together, the nation’s 29 states would form a bloc that has a bigger economy than the whole of sub-Saharan Africa, more members than the European Union, and twice the population of North America. Their gross borrowings are estimated at 3 trillion rupees in the current fiscal year, more than double the 1.2 trillion rupees for the 12 months ended March 2010, Ritesh Jain, Mumbai-based chief investment officer at Tata Asset, wrote in a note.

Uttar Pradesh, the nation’s most populous state, sold 10-year notes at a cutoff yield of 8.83 percent at an auction Tuesday, according to a central bank statement. That’s up 49 basis points from 8.34 percent at a Jan. 12 sale. The yield on sovereign bonds maturing in January 2026 rose three basis points to close at 7.86 percent in Mumbai, having increased 24 basis points from Jan. 12.

Higher state yields have “impacted sovereign bonds negatively,” said Jain of Tata Asset. “State governments have emerged as a significant source of supply” and demand for sovereign securities from some key “yield-seeking” investors such as insurance and provident funds is getting diverted to state notes, he wrote.

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