When it comes to debt mutual funds, lot of investors think of the underlying securities as being Government bonds (G-Secs), Corporate bonds (NCDs) or money market instruments (e.g. TPTs, CPs, CDs etc). Different debt and money market instruments have different risk and yield profiles. In more recent years, credit risk has emerged as an important consideration for fixed income investors. In this article, we will discuss about state development loans or SDLs which are gaining attention in the debt market and many debt mutual funds are investing in these instruments. Before deep dive into SDLs, let us understand the economics of how States function in the Indian economy.
What is Budget? Budget in the simplest term, is the account of how much the Government earns through tax revenues and other means (e.g. disinvestment, dividends for CPSEs etc) and how much the Government spends on various items e.g. regular Government expenditure on various schemes, capex (e.g. spending on infra projects) etc. If the Government spending is more than what Government earns through tax revenues, disinvestments or other means, then Government will have a fiscal deficit. How will Government meet its fiscal deficit? The Government will have to borrow money from the market and have to pay interest on it. The Government will have to issue bonds; in case of the Central Government these are called G-Secs.
We have a federal structure in India, which in economic terms means that each State will have its own Budget. The State will have revenues / receipts through various taxes like State’s share of GST, Excise Duty, and VAT on certain commodities etc, and other sources (e.g. disinvestments and dividends from State Government PSEs). Like the Central Government, the State will also have its expenses on running the administration, various State welfare schemes, interest expense on State Government borrowings and capex spending by the State. Like the Centre, the State may also have a deficit and will meet its deficit through borrowings. Each State has a borrowing limit.
The State Governments issue State Development Loans (SDL), which are bonds quite similar to Central Government Bonds or G-Secs. The issuance of these bonds is managed by the Reserve Bank of India (RBI). The investors in SDLs are usually banks, mutual funds, insurance companies, provident funds etc. From a credit risk standpoint, SDLs are considered to be equivalent to G-Secs. The RBI has the power to make payments for SDLs from the Central Government’s budgetary allocation to the States. The SDLs usually have 10 year tenures and make half yearly interest payments.
A large number of debt funds invest in SDLs. These include both passive and active funds:-
You should consult with your financial advisor to know more about debt mutual funds’ investments in state development loans and if they are suitable for your investment needs.
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