Better fiscal management and improved market liquidity can help states to reduce their cost of borrowing, the Reserve Bank Of India (RBI) stated in a latest research paper today. RBI Working Paper titled States’ Fiscal Performance and Yield Spreads on Market Borrowings in India, authored by Ramesh Jangili, N.R.V.V.M.K. Rajendra Kumar and Jai Chander constructs a composite index of States’ fiscal performance and examines if the constructed index can help in explaining the State Development Loan (SDL) yield spreads . Key fiscal parameters viz., deficit, debt, expenditure quality, revenue mobilisation efforts, and market liquidity of SDLs are considered for the composite index. The inclusion of both fiscal as well as market indicators makes the study unique and broadens the analysis.

Empirical results establish a statistically significant association of the index with SDL yield spreads suggesting that better fiscal management and improved market liquidity can help states to reduce their cost of borrowing. Further analysis of individual sub-indices revealed that deficit, expenditure quality and market liquidity are the important factors in determining yield spreads.

The paper noted that the index provides a menu of choice to state governments to reorient their policies towards improving their performance in order to reduce the cost of borrowing. The index provides investors with a single measure to make a more informed investment decision, thereby expecting to make the price discovery mechanism of SDLs more efficient.

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