New Delhi, Jan. 18: The government today excluded most states from borrowing from the National Small Savings Fund (NSSF) at a high cost from April 1, 2016, at a time interest rates in the market are coming down.

The move will help the states to raise cheaper funds from the market and reduce their interest outgo.

"The Union cabinet has decided to exclude state governments, except Arunachal Pradesh, Delhi, Kerala and Madhya Pradesh, from the NSSF from April 1, 2016," an official release said.

The NSSF rate for the current fiscal is 8.8 per cent, while the prevailing market rate is about 7.5 per cent and dipping further after demonetisation.

The interest rate of NSSF loans to the Centre and states for 2015-16 was 9.5 per cent.

"The move will benefit the states as they can borrow at a lower rate and time it to meet their needs," Aditi Nayar, principal economist with Icra, said.

The Fourteenth Finance Commission had recommended that states be excluded from investing in the NSSF.

The government is also likely to increase the cap on borrowing soon as demanded by the states at various meetings of the GST Council. However, the exact limit on borrowing will be decided later, officials said.

According to the finance commission's recommendation, the fiscal deficit threshold should be set at 3 per cent of the Gross State Domestic Product (GSDP). Over and above, it provided a headroom of up to 0.5 per cent of GSDP in a year, subject to compliant conditions on the "debt to GSDP ratio" and "interest payments to the revenue-receipts ratio".

Analysts said the states had the option of taking 100 or 50 per cent from the NSSF; most opted for the latter as they could also get a competitive rate from the market.

The cabinet decided to give Arunachal Pradesh loans up to 100 per cent of the NSSF collection within its territory. Delhi, Kerala and Madhya Pradesh shall be provided 50 per cent of the collection.

Loan to FCI

The government also approved providing a one-time loan of Rs 45,000 crore from the NSSF to the Food Corporation of India (FCI) to meet its subsidy requirements.

The move will ensure that the FCI doesn't have to take expensive cash credits and short-term loans for its operations.

A legally binding agreement will be signed between FCI, the department of food and public distribution and the ministry of finance on behalf of the NSSF on the modalities for the repayment of interest rate and principal and the restructuring of the FCI debt will be made possible within 2-5 years.

The proposed loan will cost the Centre an annual Rs 3,500 crore (at 8.8 per cent interest), while the FCI currently incurs Rs 8,500 crore (at 10.2 per cent) on short-term loan arrangements with banks, officials said.

Once the states are excluded, the investible funds of the NSSF with the government will increase. The increased availability of loan from the NSSF may reduce the government's market borrowing. The market borrowing of states, however, will go up.

Indranil Sen Gupta, the chief India economist at Bank of America-Merrill Lynch, has said he expected the net government borrowing next fiscal to be Rs 5 lakh crore, higher than the Rs 4.40-lakh-crore borrowing in the current fiscal.

The NSSF invests its net collection as loan to the Centre, states and Union Territories.