State development loans crash in October as yields remain high

New Delhi: State governments, which increased their market borrowings in the first half of FY26 to finance infrastructure projects and sustain growth momentum, saw a weak appetite for state development loans (SDLs) amid no substantial changes in yields during October.

The latest data from the Reserve Bank of India (RBI) showed SDL issuances slumped 52.88% to ₹57,010 crore in October from ₹1.21 trillion in September, the highest monthly borrowing this fiscal. In October 2024, states had raised ₹64,842 crore.

To be sure, the lack of any substantial relief in yields coincided with a dip in state bond supply in October, as several states temporarily paused fresh issuances. The 10-year SDL yield is currently around 7.20%, weighed down by an oversupply of state bonds in recent months and subdued investor demand, preventing any meaningful easing. Yield is the return an investor earns on a bond, expressed as an annual percentage of its price. It reflects the income generated, typically through interest payments, relative to the bond’s market value.

The Reserve Bank of India (RBI) manages the issuance of these bonds, which are sold through auctions and have a quasi-sovereign status, making them a low-risk investment.

Competition for funds

Unlike previous years, when states typically borrowed in the final quarter when central issuance tapers off, this fiscal year has seen a steady flow of auctions since April, with both central and state papers vying to tap investor demand.

Between April and September, states collectively raised ₹5.01 trillion through SDLs, up from ₹3.86 trillion in the same period last year, though below the combined borrowing target of ₹5.60 trillion for the first half of FY26, as per the RBI’s calendar. However, during the September quarter, actual borrowings came in around ₹3 trillion, exceeding the target of ₹2.87 trillion. For the December quarter, states and union territories are projected to borrow ₹2.82 trillion.

The pickup in early borrowing follows a broader rise in state debt levels. Total SDL issuances in FY25 hit a record ₹10.73 trillion, up 7% from FY24, with an unprecedented ₹4.34 trillion raised in the March quarter alone.

States typically rely on tax revenues, central transfers, GST compensation, and interest-free loans in the first half of the fiscal year before turning to market borrowings, which are usually costlier, in the second half.

However, SDLs, which are issued within borrowing limits set by the central bank, remain a critical instrument for bridging state fiscal deficits.

Uncertainty lingers

Market participants said that while the moderation in SDLs has brought brief relief to the market after months of continuous supply pressure, borrowing trends in the coming months remain uncertain and could pick up again based on states' financing needs and fiscal requirements.

“The sustained premium continues to reflect a combination of persistent long and ultra-long tenor issuances from both the centre and the states, muted domestic demand, and limited foreign portfolio investor (FPI) flows. Even though the centre has marginally reduced its ultra-long supply, the 10-year segment remains active, keeping relative yields elevated,” said Venkatakrishnan Srinivasan, managing partner at Rockfort Fincap LLP, a financial advisory firm.

“External factors have added to the firmness. US tariff concerns, elevated US Treasury yields, a bout of weakness in the rupee, and subdued offshore sentiment have kept the benchmark 10-year government securities (G-Sec) yield from declining further. Despite India’s inclusion in global bond indices, FPI inflows into Indian debt have remained small, constraining incremental demand for duration-heavy securities,” he added.

In September Bloomberg reported, quoting sources, that many of India’s largest banks had told the RBI they were nearing their internal limits for state bond holdings as the share of such securities in their investment portfolios had risen sharply.

As things stand, banks remain the main buyers of state bonds, and any pullback on their part could strain states’ access to funds. A RBI spokesperson didn’t immediately respond to Mint's emailed queries.