Just like an individual, State Governments in India 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 service their interest at half-yearly intervals and repay the principal amount on the maturity date. They are generally issued for ten years.

The RBI manages these SDL issues. RBI also makes sure that the SDLs are serviced by monitoring payment of interest and principal.

But this does not mean that RBI guarantees SDLs. Like the government bond market, SDLs are also traded electronically. The participants mainly include banks, mutual funds, insurance companies, provident funds, and others. Earlier, the daily traded volumes used to be less than 5% of government bond traded volumes. These are one of the most liquid instruments that can be bought and held for the long term. Sometimes spread may be higher than the 10- year Government Bond. This rise is mainly due to interest rate outlook for the future, liquidity for investments, and appetite for such investments by institutions.

Compared to AAA Corporate bonds, these have lesser risks with the sovereign guarantee. SDL securities are considered superior to loans mobilized or bonds issued by corporates. The RBI has the power to make repayments to SDLs out of the central government allocation to states. The Reserve Bank of India 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.

The yield by these papers may be higher than the central government benchmark yield.

They may provide higher yield above government bond yields. The trading is done through auctions, in the same way as it is conducted for bonds issued by the Central Government.

SDLs may not prove to be a good option for short term debt funds. Generally, the Government and Indian debt markets predominantly feature in the Indian Debt Market. Until recently, the state development bonds did not receive the required attention because of the lack of supply. However, this is changing over the years as their supply goes up. One can place them somewhere between G-secs and corporate bonds, both in terms of credit risk and spreads.

Rating agencies such as CRISIL provides the prices of these SDLs every business day.

Being issued by the Government, these Bonds are one of India's most secure forms of investment due to the Sovereign guarantee. In case you are a risk-averse investor who places the security of investments, first, you can look to invest in these securities. Investments in these bonds can also be for those with no experience of investing in mutual funds. These can be a good option if you are seeking to dilute or diversify your investment portfolio.

While checking your debt mutual funds, please take note of the percentage of SDLs in it. Ask your fund manager if spreads on SDLs are worth taking the risk and whether the state has reasonably good finances. Generally, a State Government that has healthy finances will trade at lower spreads. Sometimes, there may be some concerns amongst market participants about the credit status of SDLs and SDLs' serviceability resulting in a rise in spreads. But this may correct in the long term.

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