Special bonds pose risk to India deficit - JP Morgan

MUMBAI (Reuters) - Heavy special bond issuances by the Indian government to state-run firms are threatening to swell the fiscal deficit and dim chances of a ratings upgrade in the coming years, JP Morgan said in a recent note.

India issues special bonds to oil, food and fertiliser firms to help them cut their losses incurred by selling them at state-set prices which are lower than global benchmarks.

According to the Fiscal Responsibility and the Budget Management Act (FRBM) which was operationalised in 2004/05, the government must reduce its fiscal deficit to 3 percent of GDP and wipe out its revenue deficit by 2008/09.

"The pickup in special bond issuance should concern investors," JP Morgan said. "Indeed, such issuance provides the government a convenient way to skirt the strict requirements of the FRBM act."

JP Morgan estimates the total outstanding stock of special bonds at 872 billion rupees, about half the government's borrowing plan for 2007/08 and redemptions worth 133 billion are expected by March 2009 -- which means it has to provide for them -- in effect swelling the overall borrowing target.

It expects the government to sell about 320 billion rupees of oil bonds alone in the current fiscal year to end-March. The government has sold 241.21 billion in 2006/07 and 172.63 billion in 2005/06, data from the central bank showed.

These special bonds are not considered as part of budgeted expenditure or receipts, but interest payments on such bonds are part of the revenue expenditure, affecting the revenue deficit and has a cascading effect on the fiscal deficit.

JP Morgan expects these subsidies to push the government's liabilities up by 2-2.5 percent of GDP.

The federal budget for 2008/09 will be presented on Feb. 29.