An increased funding burden on the states under India’s revamped rural jobs guarantee scheme is expected to push up their borrowings and send bond yields higher, according to market participants.
The Viksit Bharat-Guarantee for Rozgar and Ajeevika Mission (Gramin) (VB-G RAM G) Act shifts the Centre-state funding ratio to 60:40 from the current 90:10 under the Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS).
The higher funding responsibility on states would increase borrowing requirements, widen the spread or yield gap between state development loans (SDLs) and government bonds, and limit any near-term softening in sovereign bond yields, which have remained elevated for most of the year, according to at least five market participants who spoke with Mint.
“Willy-nilly, states will have to borrow more. On a net basis, borrowings will rise, and that will again have implications for yields,” said Killol Pandya, head of fixed income at JM Financial Asset Management. While higher yields may initially attract investors who have stayed away back to SDLs, Pandya warned that excessive supply could eventually lead to illiquidity.
“There will be a tipping point. If everyone’s limits are packed, secondary market volumes will fall, and yields will have to move higher to entice buyers,” he said, adding that inter-state spreads could also widen, especially for high-population states that rely more heavily on the MGNREGS.
A rise in market borrowings and an uncertain global environment have already widened the spreads between 10-year benchmark government bonds and SDLs to 65-98 basis points in last week’s auction. This is higher than historical spreads of 30-40bps. One basis point is one-hundredth of a percentage point.
As it is, the benchmark yield, an indicator of the risk-free borrowing rate, has been rising. On 22 December, yield on the 10-year government bond touched a nine-month high of 6.68%. It was trading at 6.57% on Wednesday.
Rising debt
Last week, Parliament passed the VB-G RAM G Bill, and it has also received the presidential assent. The scheme alters the funding pattern of the employment guarantee between the Centre and states to a 60:40 ratio, resulting in a threefold increase in the burden on states, Mint reported on 20 December.
If states are unable to provide employment to a worker within 15 days of the request, they are liable to pay unemployment benefits. The Centre will then decide the budget allocation for each state. Any spending by states exceeding this amount will have to be funded by them.
For 2025-26, the Centre had allocated ₹86,000 crore to the MGNREGS, one of the top expenditure items in its budget.
Once the new 60:40 formula is implemented, states will face an additional burden of around ₹30,000-40,000 crore, said Paras Jasrai, associate director and economist at India Ratings and Research.
This comes when state finances are already strained by populist schemes, weak nominal gross domestic product (GDP) growth and subdued tax buoyancy. Additionally, market demand has remained subdued among long-term investors and banks.
“In the upcoming budget, state borrowings are going to go up while the Centre may still manage it. I have heard numbers as high as a 20% increase in state borrowing. Now, with the change in the MGNREGA, it will have a state liability also. So, now if state borrowings go up, you will see a further yield pressure coming in,” a senior treasury official at a private bank said, on condition of anonymity.
In 2024-25, states borrowed ₹10.73 trillion, 7% higher than 2023-24.
The pipeline is already heavy even before the impact of the MGNREGS revamp is factored in.
So far in 2025-26, they have raised ₹6.84 trillion from the market, which accounted for over 81% of their planned borrowing as of the December quarter, according to a 16 December Bank of Baroda report. During the corresponding period in the previous fiscal, the states had borrowed ₹5.84 trillion.
The 2025-26 budget estimate has pegged the states’ combined fiscal deficit at ₹11.4 trillion, or 3.2% of GDP, within the indicative limit of 3.5% of GSDP (gross state domestic product) ratio allowed by the central government, India Ratings and Research said in a 6 May report.
Implications
Widening of spreads across the market often signals increased risk aversion among investors, resulting in higher borrowing costs.
So far, bond markets have been pinning their hopes on the March quarter. They expected more demand from pension funds and foreign portfolio investors to return from the holiday season and invest in government bonds, bringing down yields and compressing spreads.
“But with more and more such news coming with the supply in SDL will be higher, globally dollar is not cooling off, and Japanese depreciation is also happening, it looks difficult for the bond market to show any softness going forward,” another private-bank treasury official said, on condition of anonymity.
The SDL abundance could come even as the Reserve Bank of India (RBI) is pushing more liquidity into the banking system to soften the yields. On Tuesday, the RBI said it would ramp up liquidity operations next week and in January with large-scale open market operations (OMOs) of ₹2 trillion and a dollar-rupee buy/sell swap auction of $10 billion, amid tight systemic liquidity and sustained pressure on the rupee.
“I think the next big thing is actually the budget because that will determine where your yields are headed. And if I were to hazard a guess, I would not be surprised if 10-year G-sec touches 6.75%,” the first treasury official quoted earlier said.
While some market participants believe that the revamp of the MGNREGS is a step towards greater fiscal discipline, most expect higher state borrowing calendars in the near term.
An additional fiscal burden would coincide with uncertainty around the 16th Finance Commission’s recommendations and ongoing debates over devolution and income transfers, particularly involving southern states such as Tamil Nadu and Karnataka, Jasrai of India Ratings said.
“With nominal GDP growth running below 9%, tax buoyancy has been weak,” he said. “States may be forced to raise non-GST (goods and services tax) taxes, rationalize user charges, or cut back on capital expenditure growth.”
