The Reserve Bank of India will provide more short term financing to state governments, which have seen expenses surge and revenues dry up due to a 40-day nationwide lockdown.
The lockdown was announced by Prime Minister Narendra Modi on March 24 to curb the spread of Covid-19.
In an announcement on Friday, the RBI said that the limit for ‘Ways and Means Advances’ for state governments is being raised by 60 percent over and above the limit as of March 31, 2020. An earlier announcement to increase the limit by 30 percent appears to have been subsumed within this announcement.
Ways and means advances are temporary loan facilities provided to the central and state governments to enable them to meet temporary mismatches between revenue and expenditure. The government makes an interest payment to the central bank when it borrows money. The rate of interest is the same as the repo rate, while the tenure is three months, with a 21-day period of overdraft permitted.
The higher WMA limit is expected to temper the surge in issuance of state government bonds, known as state development loans or SDLs in technical parlance. This, in turn, will allow interest rates on state borrowings to ease from “alarmingly high levels seen in the last six weeks,” said Jayanta Roy, senior vice president at ICRA.
States will pay an interest rate of 4.4 percent on WMA borrowings, compared to an interest rate of 7.65 percent that they are paying on 10-year bonds.
So far, state governments have issued bonds worth Rs 44,778 crore in the first month of the current fiscal year, compared to Rs 29,572 crore in all of April last year.
Most states had weak finances even before the onset of the pandemic. Fiscal deficit as a percentage of the Gross State Domestic Product for several major states was already at the 3 percent limit or marginally below it, according to budget documents for FY21.
Since the spread of the pandemic, states have increased spending on healthcare and income support for those impacted by Covid-19. Consequently, state finances have weakened further.
According to Govinda Rao, chief economist at Brickwork Ratings and member of the Fourteenth Finance Commission, the higher WMA limit gives immediate liquidity to states, while helping them space out their market borrowings. This is an immediate relief measure, he added.
It may not eventually solve the problem for states as funding requirements in fighting the Covid crisis may be long term in nature. Equally, the expected revenue shortfall may last through the course of this financial year due to a sharp slowdown in growth.
This is not entirely adequate, Rao said, adding that the centre may need to increase state borrowing limits under the Fiscal Responsibility and Budget Management Act by an additional 1-1.5 percent of Gross State Domestic Product.
The central government’s borrowing program is also likely to increase this year. Eventually, the central bank will have to monetise the deficit, either directly or through open market operations, Rao said. “They cant avoid doing that,” he added.
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