Indian investors often invest in State Development Loans (SDL) over corporate bonds or government securities. State Development Loans offer a relatively higher interest rate than other securities. This makes it attractive to Indian investors. Learn what are state development loans in detail to make an informed decision.
What Are State Development Loans?
State Development Loans (SDL) are popularly known as state government bonds or SDL bonds. The state governments issue these bonds to meet fiscal deficits. These bonds usually have a maturity tenure of 10 years. However, issuers can set different maturity tenures.
The Reserve Bank of India (RBI) regulates SDL, ensuring sovereign guarantee and eliminating credit risk associated with these bonds. Investors receive interest payout every 6 months on these bonds while the principal is repaid at maturity.
Banks, EPFO, insurance companies, corporates and mutual funds are the primary investors in SDL, in addition to individual investors. In case an SDL results in default at maturity, the RBI is liable to repay the principal to investors.
Investors can purchase SDLs at standard auctions that the RBI conducts in the primary market. Moreover, they can consider trading in SDL in the secondary market as well.
Notably, the fiscal strength of a state is inversely related to the interest rate of SDLs. If a state has a promising fiscal strength, the interest rates will be relatively lower.
Features of State Development Loans
Here are the features of SDL to elaborate on what are state development loans:
Predetermined Coupon Rate
The coupon rate of SDL is fixed through auctions conducted by the RBI. As a result, investors receive a fixed income from interest semi-annually. This interest rate is often higher than G-secs.
Implicit Sovereign Guarantee
Even though the RBI does not directly ascertain SDLs, it acts as a backup allowing the Central Government to repay in case states default at the time of SDL repayment at maturity. This ensures a sovereign guarantee and safety as compared to corporate bonds.
Tradable in the Secondary Market
Investors can trade in SDLs at the Indian stock exchanges in the secondary market. Thus, there is no lock-in period for SDLs making it liquid.
Held in Demat Accounts
As an investor, you can hold SDLs in dematerialised form in demat accounts for convenient transactions in the secondary market.
Collateral for Loans
Investors can use SDLs as collaterals to secure loans, making them a flexible investment option.
What Are the Benefits of Investing in State Development Loans?
Here are the benefits of SDLs that help you understand what are state development loans:
Lower Risk
SDLs come with a sovereign guarantee wherein the Central Government guarantees to repay the principal to investors on maturity if a state government defaults. Further, the RBI regulates the issuance of SDLs and ensures repayment by the respective government. This makes the associated risk lower compared to corporate bonds.
Higher Return
Usually, SDLs provide a relatively higher yield compared to government securities. The higher interest rate of SDLs is usually between 25 and 50 basis points.
Liquidity
Investors can trade SDLs in the secondary market as there is no lock-in period. Further, the RBI allows the use of SDL as collateral for loans under the RBI Liquidity Adjustment Facility. This ensures liquidity in SDL investments.
Ways to Invest in State Development Loans
Once you understand what are state development loans, you can choose to invest in SDLs in either of the following ways:
Direct Investment
If you have a demat account, you can invest in SDL directly in the primary market. Ensure you are associated with banks and authorised stock brokers that allow trading in such securities.
You can select an SDL based on the tenure, credit rating and yield. Understanding bond market dynamics and possessing direct investment management skills are essential for direct SDL purchases.
Investment Through Mutual Funds and ETFs
SDL-focused mutual funds and ETFs (Exchange Traded Funds) have a portfolio of SDLs managed by experienced fund managers. Fund managers ensure portfolio diversification based on the market conditions. This reduces the risk for investors while allowing them to invest in SDLs indirectly.
Who Should Invest in State Development Loans?
Based on your investment objective, you can choose to invest in SDLs. However, the following categories of investors can consider investing in SDLs:
Risk-averse Investors
SDLs are low-risk investment instruments. As a result, risk-averse conservative investors can consider investing in SDLs with lower risks, as compared to corporate bonds.
Investors Looking for a Stable Income
The interest or coupon rate of SDL is fixed. Further, the interest is payable semi-annually, ensuring stable and regular income for the investors.
Investors with Portfolio Diversification Plan
Investors looking for portfolio diversification can purchase SDLs to balance the risk level of their portfolio. SDLs can easily counterbalance stocks or corporate bonds associated with high risks.
Taxation on State Development Loans
The interest income from SDL is taxable based on the income tax slab of the investor. Notably, there is no TDS applicable to the interest earned by investors. However, SDLs are listed instruments, attracting capital gains tax on transfer, based on the holding period.
If the holding period is less than 12 months, STCG applies based on the investor’s tax slab and rate. In case the holding period exceeds 12 months, LTCG applies. The applicable LTCG is 12.5%, in addition to cess and surcharge.
Risks Associated with State Development Loans
Here are the anticipated risks associated with SDLs:
Credit Risk
Even though SDLs come with a sovereign guarantee, investors should be aware of the fiscal deficit of the state. Choosing an issuer with a low fiscal deficit can help mitigate credit risks. Developed states in India such as Gujarat, Maharashtra, Karnataka and Tamil Nadu are prominent states issuing low-risk SDLs.
Interest Rate Risk
The interest rates and bond prices are inversely related. Investors need to be aware of the interest rates in the economy while purchasing or trading in SDLs. An increasing interest rate in the economy can affect the bond yield significantly. Holding these bonds for over 3 years can help investors adjust to the short-term volatility of interest rates.
Final Word
To answer what are state development loans, it is essential to mention that these are low-risk, sovereign-guaranteed investments with fixed coupon rates. Investors receive interest payout periodically, ensuring a stable income source.
As an investor, you can invest in SDLs directly using your demat account or indirectly through mutual funds and ETFs, based on your convenience and risk appetite. While direct investment requires extensive knowledge and management skills, indirect investment allows fund managers to diversify investor’s portfolios to reduce risks.
Frequently Asked Questions
The maturity tenure of state development loans is usually 10 years. However, it might vary based on the issuer. Nevertheless, investors can trade in SDLs in the secondary market as there is no lock-in period.
The RBI does not guarantee repayment of state development loans directly. However, the RBI regulates SDLs to ensure that investors are repaid their principal either by the issuer or by the Central Government if the issuing state government defaults.
Investors of State Development Loans receive interest payout twice a year. This interest rate is fixed through the primary auction that the RBI conducts and remains unchanged throughout the SDL tenure.
