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Fiscal federalism

India takes another important step towards fiscal federalism on Mondaythe first auction of state government debt to foreign investors

India takes another important step towards fiscal federalism on Monday—the first auction of state government debt to foreign investors. The amounts involved are small given the total stock of debt issued by the states.

The Reserve Bank of India said last month it will allow foreign portfolio investors to buy sub-national debt. The first few auctions will be interesting to follow for clues about how bonds will be priced depending on the fiscal strengths of various states. It also remains to be seen if pricing by foreign investors will prompt domestic banks to demand higher interest rates from mismanaged states.

The central bank has capped the amount of state debt that can be sold to foreigners. So India may not immediately face the sort of problems China has had to, thanks to a large stock of local debt that now threatens financial stability.

Will the logical next step be greater financial flexibility to the third level of government, especially the cities?

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