The bond market is not flinching at states getting a raise in their borrowing limit, as most governments will be excluded due to the conditionality attached.

Instead of yields rising due to oversupply fear, the 10-year bond yield closed at 5.774 per cent on Monday compared to its previous level of 5.78 per cent.

Soumya Kanti Ghosh, chief economic advisor for the State Bank of India group, noted that only eight states qualify for the extra borrowing, given the broad conditions of ease of doing business, power distribution rank, and the number of urban local bodies. Another condition, of One Nation One Ration card, is new and states will take time to fulfill it.

States, if they meet all conditions, can borrow 5 per cent of their Gross State Domestic Product (GSDP), against 3 per cent allowed now. The extant ceiling of borrowing, at 3 per cent of GSDP, is Rs 6.41 trillion, of which the states have used up 14 per cent. According to the central government, the extra borrowing provision could give states room for Rs 4.28 trillion more borrowings.

The states get an unconditional increase of 0.5 per cent of their GSDP. However, for the rest, there will be conditions attached. So, 1 per cent increase in borrowing will be linked to specified, measurable, and feasible reform actions. There will be a further 0.5 per cent increase if three out of four reform areas are met.

But calculation shows that it will be very hard for states to meet the goals even during normal situations. For example, West Bengal and Odisha are not part of the UDAY scheme, and therefore, rank low in power distribution criterion, as per SBI calculation based on state data. These states, as well as Kerala also have low urban local body count. Bihar also doesn’t qualify in most front.

“Our research suggests that out of 20 states only 8 states are in the position to fulfill all the conditions of Government and can avail 2 per cent of GSDP as extra borrowing. Hence, out of Rs 4.28 lakh crore we believe that only Rs 3.13 lakh crore (73 per cent of total available) might be actually borrowed by the state governments in FY21,” Ghosh wrote in a note.

“We find some of the states like West Bengal, Telangana, Bihar, Odisha, Assam, Jharkhand, Chhattisgarh need to fulfill the conditional ties to avail of the borrowings,” Ghosh said.

Given the conditions attached, it is unlikely that states will rush to borrow now. But there could be some increase in supply near the year-end, when the states mainly borrow. Meanwhile, bond yields are driven by how the stimulus package is not really disturbing the fiscal math of the government by a wide margin.

“Markets saw that the stimulus package did not involve much of cash outflows and relied on guarantees, full and part, and deferrals etc., and thus was relieved that no big borrowing may be needed,” said Harihar Krishnamurthy, head of treasury at First Rand Bank.

“Also, liquidity is very plentiful with about Rs 7 trillion. Mutual funds are buying Gsecs which is safest from credit risk. Finally, country downgrade fears have also abated as our total package is below other country percentages,” Krishnamurthy said.