Bonds are debt instruments in which the investor loans money to the issuer. The issuer borrows money at a fixed interest rate for a specific time duration. Such an issuer can be government, banks or corporates. Hence, when the state government issues bonds, they are known as state government bonds. Here, in this article, we have covered in detail about state development bonds.
What are State Development Bonds in India?
State governments in India allocate budgets to run their state expenditure. Sometimes, the state expenditure may get higher than the allocated budget. In other words, the expenditure is more than the revenue. This situation leads to a fiscal deficit in the state. Therefore, to fund the fiscal deficit requirements, the state government issues State Development Bonds or State Development Loans (SDLs). Every state has a set limit up to which they can issue bonds to borrow.
The structure and nature of state development bonds are very similar to a government bond. In simple words, they pay the coupons either half-yearly or annually and repay the principal amount on the maturity date. Moreover, these instruments are issued for a maturity of 10 years or more. Also, the re-issuances for SDLs are very rare.
How Does a State Development Bond Work?
Generally, the RBI manages the issue of State Development Bonds. RBI also ensures by monitoring the periodical interest payments and principal on maturity. Moreover, it also can make repayments from the central government allocation to states.
RBI auctions the SDLs through an electronic auction system via the E-Kuber portal once a fortnight. Also, these bonds do not have credit risk as they are similar to central government securities. This means that they come under the CRAR prudential guidelines. The risk weight of SDL is zero, and banks need not keep any capital for investing in SDLs. Such specifications and higher yields have encouraged banks to invest in them in recent years. Therefore, states are able to meet their borrowing requirements.
Furthermore, the SDLs are traded electronically on the RBI managed NDS-OM (Negotiated Dealing System-Order Matching) and traded in the voice market (NDS). Also, the rate of interest is determined through an auction. Therefore, the SDL prices and yields move based on various factors like the market interest rate cycle, the yield of new issuances, demand, etc. Therefore, these fluctuations will appear in the bond prices.
Purpose of a State Development Bond
A state development bond is a debt security where state government issues to finance their needs. When the state government requires funds for infrastructure development and financing government spending, they issue SDLs. The state government will sell these bonds to the public, inviting investments. The government will pay back the principal and interest as per the clause on the maturity date. Therefore, the primary purpose of state development bonds is to finance the state fiscal deficit. RBI issues these bonds on behalf of the state government.
State Development Bonds are market-linked instruments for states to utilise funds in the open market. The higher the state’s fiscal strength, the lower interest is payable for the borrowings. Moreover, RBI also promotes the issue of SDLs in the market. SDLs are considered to be superior to loans or other government bonds.
Main Investors of a State Development Bond
The following are the main investors of State Development Bond –
- Commercial Banks
- Mutual Funds
- Insurance Companies
- Pension Funds
- Provident Funds
- Any other Financial Institutions
Usually, these large investors are attracted by slightly higher interest rates than other government bonds. Lately, SDLs is also open for retail investors where the minimum bidding amount is Rs.10,000 and in multiples of Rs.10,000 thereof.