BackUDAY scheme bonds to pay lower interest
Rajasthan issued UDAY bonds at rate of 8.39%, less than 8.55% paid by state to raise Rs1,000 crore at an 8 March auction
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New Delhi: The bonds issued by state governments under the Ujwal Discom Assurance Yojana (UDAY) scheme to revive loss-making power distribution companies (discoms) will ironically pay a lower interest or coupon than state development loans (SDL) issued by the governments under their normal borrowing programme. In a tweet on Wednesday morning, power minister Piyush Goyal said that Rajasthan issued UDAY bonds at a coupon rate of 8.39%. This is lower than the 8.55% paid by the state to raise ₹ 1,000 crore at the last state government bond auction on 8 March. What makes this possible is a single diktat by the centre that state government bonds issued in lieu of discom loans will be issued at a coupon of up to 75 basis points (bps) over the corresponding benchmark 10-year central government bond.
The Rajasthan government timed it well as the benchmark 10-year yield has fallen after the budget on 29 February. The yield was at 7.57% on Wednesday, down 19 bps since 1 January. One basis point is one-hundredth of a percentage point. Under the UDAY scheme, states will take over 75% of the outstanding debt of distributors. UDAY bonds will have a five-year moratorium on repayment and only the interest payments would be included in the calculation of states’ fiscal deficit, which is capped at 3% of the state gross domestic product (GDP). The outstanding debt of discoms as of September 2015 was ₹ 4.3 trillion.
According to two bankers, Uttar Pradesh, Bihar and Haryana are likely to issue bonds against their outstanding discom loans in the next 10 days.
“Discom bond issuance will now begin and UP, Haryana and Bihar are already in talks with banks," said one of the bankers requesting anonymity.
Rajasthan government issued a massive ₹ 28,500 crore worth of bonds to 26 banks late on Tuesday in lieu of its three power discoms under the UDAY scheme.
Worries that once UDAY bonds land on banks’ investment books, demand from lenders for government bonds and SDLs would wane had driven up state bond yields by 25-30 basis points over the last two months. Even the 10-year benchmark government bond yield has risen by 10 bps on these concerns between 1 January and 25 February. States have ended up borrowing ₹ 3 trillion in fiscal 2016, a 35% jump from the previous year. Uttar Pradesh borrowed ₹ 1,200 crore at 8.58% at the 8 March auction while Bihar borrowed ₹ 3,200 crore at 8.6%. Haryana had borrowed ₹ 2,500 crore at 8.51% on 9 February. These states had borrowed at a yield at least 25 bps less in auctions in January.
While the UDAY bonds appear to be paying a lower yield, unlike SDLs these papers do not have Statutory Liquidity Ratio (SLR) nor can they be kept in the held-to-maturity (HTM) portfolio of banks. An SLR status enables banks to use these securities to borrow from the Reserve Bank of India’s liquidity windows. Banks have to hold a mandatory 21.5% of their deposit base as SLR, which ensures captive demand for bonds eligible to be classified as SLR. Meanwhile, classification of bonds under HTM shields such investments from mark-to-market losses. On 27 February, RBI had indicated that it would consider allowing UDAY bonds to be held under HTM although no formal circular has been issued, according to the bankers cited above. “This is a big flaw in these bonds which the RBI needs to check," said the second banker. Apart from the additional state government debt that banks will now be sitting on, they will also have to take a hit of about 3-4% as these bonds have a far lower yield than the interest on loans given to discoms. Lenders had extended loans to discoms at 12-14% while most of these bonds will end up paying no more than 8.50%.
Bankers are hopeful that they would find eager buyers among insurance companies and provident funds for UDAY bonds.
“These bonds offer a good yield and are state-backed. Long-term investors like insurance companies will be very much interested," said the first banker. However, given that SDLs are at present offering a higher rate, interest from non-bank investors is not assured.
“These are not SLR bonds. There is already an excess SLR in the system. To that extent, yes these will impact the demand from banks. But these bonds also offer less yield than SDLs and g-secs. So who will buy these bonds? By keeping the yield of UDAY bonds below SDL, the government has ensured that these don’t affect the demand for government bonds and SDLs. This is a non-starter in terms of trading and banks would end up putting these bonds in HTM," said Nilesh Shah, MD of Kotak Mahindra Asset Management Co. The positives for banks are that the remaining discom loans would attract lower provisioning now as they would be classified as standard. “Due to change in the ownership/structure of the loans, it should get upgraded to standard category immediately. SEB restructured loans account for 1-3% of total loans for PSU banks," said Parag Jariwala, vice-president–institutional research, banking and financial services, Religare Capital Markets. He said that banks that have the highest exposure to discoms will benefit the most.
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