Views of chief india economist,jp Morgan

Last year, total expenditure at the state level (17.1 per cent of the GDP) was much higher than the Centre’s expenditure (13.3 per cent), So, it’s natural to ask what market signals state bonds are getting. Much is made of the ebbs and flows(up and down,उतार चढ़ाव)] of yields[yee(-u)ld(return,मुनाफा)] of Central government securities (G-Secs) because they reflect the cost of government borrowing and create market-based incentives to remain fiscally prudent[proo-d(u)nt(wise,बुद्धिमान)] at a time when the FRBM Act has occasionally been “relaxed” and fiscal roadmaps changed.
Rajasthan’s fiscal deficit last year was twice that of Gujarat. Yet, its bond yields trade 1 bps below Gujarat’s. Why is Gujarat not being rewarded and Rajasthan not facing a higher cost of borrowing? with only a 6 bps difference between the highest and lowest among the 14 states that participated in the October 13 auction?

One could argue that markets take into account both explicit[ik'spli-sit(direct,प्रत्यक्ष)] and implicit[im'pli-sit(indirect,अप्रत्यक्ष)] (SEB) liabilities to have a broader definition of debt.
Instead, there seem to be two other fundamental issues driving the distortionary pricing. First, while there are no explicit sovereign guarantees, On the back of this implicit guarantee, it doesn’t matter what states’ individual vulnerabilities[vúl-nu-ru'bi-lu-tee(weakness,कमज़ोरी)] are because, if things go pear-shaped, the Centre will step in. These perceptions are likely reinforced[ree-in'forst(strengthen,मजबूत)] by the fact that the risk-weights assigned to state loans for the purposes of capital adequacy[a-di-kwu-see(sufficiency,पर्याप्तता)] are zero. To be sure, there is also a Consolidated[kun'só-li,dey-tid(strong,मजबूत)] Sinking Fund (CSF) that is managed by the RBI.

Second, there’s no real market for state bonds, with virtually no secondary market trading. Last month, they allowed FPIs to invest in state bonds, albeit[ol'bee-it(even though,यद्यपि)] to a limited extent (they can only hold 2 per cent of the outstanding stock by March 2018).
States will not be rewarded by markets for prudence, nor punished for profligacy[pró-fli-gu-see(spending unnecessary,फ़िज़ूलखर्ची)].

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