Government securities (G-Sec) are often known for their safety and guaranteed returns. In our previous post, we discussed two out of three major G-Secs – Treasury Bills and Government Bonds.
And in this post, we’re going to discuss the third type of G-Sec – State Development Loans (SDL), often referred to as State Government Bonds.
We’ll help you understand SDLs, how they work, and whether you should invest in them.
Estimated read time: 3 minutes and 59 seconds
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Buckle up. Here we go!
What are State Development Loans (SDLs)?
Just like us, State Governments also run their budgets. Sometimes a state expenditure may shoot higher in these budgets than the revenue. This situation leads to a fiscal deficit. State Development Loans (SDL) is a bond issued by state governments to fund this fiscal deficit. Each state can borrow up to a set limit.
SDLs serve as a way for state governments to finance infrastructure projects, healthcare, education, and other important programs that contribute to their states’ development.
Just like other central government bonds, the RBI manages SDL. RBI makes sure that the SDLs are serviced by monitoring the payment of interest and principal. However, this does not mean that RBI guarantees SDLs.
Yes, SDL doesn’t carry a sovereign guarantee. And for that reason, these also provide 0.25% to 0.5% extra yields compared to long-dated government bonds.
How do state development loans work?
Don’t get confused by the term loans in the name of SDLs. They work the same way as the government bonds of the central government work.
RBI auctions SDLs almost every week. You can check the future auctions here. The auction process of all G-Secs is almost the same. We have explained the auction process of the G-Sec here.
With a minimum investment amount of ₹10,000, you can invest in SDLs through NSE, banks, or your online stock broker like Zerodha. One popular way to invest in SDLs is through the Retail Direct Gilt Account, a platform that allows retail investors to buy government securities directly from the RBI.
If you are new to the concept of bonds, check out our bond series, where we have covered the basics of bond investments.
How to interpret SDLs names or symbols?
Every bond issued has a unique name or symbol. The names or symbols of SDLs typically provide essential information about the bond’s features, such as maturity and coupon rate. And yes, this is similar to the government bonds.
For example, here is a symbol – 765TNSDL27, and what this means is –
Annualized interest – 7.65%
State – Tamil Nadu (TN)
Type – State Development Loans (SDL)
Maturity – 2027
This issue is expiring in 2027. If you were to invest in this bond, you would receive a 7.65% interest every year until its maturity in 2027.
Please note that the interest will be paid semi-annually, so you will get 3.83% interest twice a year. Finally, upon maturity, you will also get back your principal amount.
Benefits
- Lesser risk: SDL securities are considered superior to corporate bonds. The RBI has the power to make repayments to SDLs out of the central government allocation to states. The RBI maintains a fund that provides contingent liabilities arising with respect to borrowings by undertakings of the state. That is why it may create an implicit assumption that RBI guarantees SDLs; however, it is not valid.
- Higher returns: The yields provided by SDLs are generally higher than other G-Secs.
- Steady income: SDLs provide a predictable and stable source of income through regular interest payments. This can be especially appealing for retirees or those seeking a fixed income stream.
Disadvantages
- Low liquidity: While you can sell SDLs in the secondary market before maturity, the volume in the secondary market is very low. It is said that trading volumes of SDLs remain very low (around 5% of G-sec volumes).
- Market risk: The prices of SDLs can also be influenced by market sentiment and the financial health of the state government issuing the bonds. This introduces an element of market risk to your investment.
- Interest rate risk: The prices of SDLs in the secondary market can be sensitive to changes in interest rates. If market interest rates rise, the value of existing SDLs may decline.
Why and when should you invest in SDLs?
Now that you have a better understanding of SDLs, let’s discuss when it makes sense to invest in them:
- Stability: SDLs are an excellent choice for conservative investors who prioritize stability and safety in their portfolios. If you’re risk-averse and want to protect your capital, SDL can be a valuable addition.
- Regular income: If you require a steady stream of income, such as retirees looking for a pension-like income, SDLs can be a reliable source of interest payments.
- Diversification: Even if you have a well-rounded investment portfolio, adding SDL can enhance diversification and reduce overall risk.
- Medium to long-term goals: If you have financial goals that are a few years away, such as buying a home or funding your child’s education, a small portion of your portfolio in long-term SDL can help you achieve those objectives while preserving your capital while reducing the overall risk.
State Development Loans (SDLs) offer a secure and income-generating investment avenue. They can help you achieve your financial goals while safeguarding your capital.
However, like all investments, it’s essential to assess your risk tolerance and investment horizon before diving in. And because of its liquidity problem, we wouldn’t recommend investing in SDLs unless you can hold your investments till maturity.
Remember that SDLs are just one piece of the investment puzzle, and a well-rounded portfolio may include a mix of different assets to achieve your financial aspirations.
Remember to share these insights with your buddies. Until next time!
Still Curious?
If you are like me, who likes to analyse a little more or check out content in different formats, well you are in luck. Below you can find some suitable content we found.
RBI – Government Securities Market in India – A Primer
WintWealth – What are State Development Loans (SDLs) and why are they issued?
Mint – Why the market doesn’t price in risk for state development loans
Note: We don’t have any affiliation with them. We are sharing links only for educational purposes. The opinions expressed by them belong solely to them and do not reflect the views of Vrid.