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Tata Capital > Blog > Generic > State Development Loans (SDLs): Definition and Motivation Behind Issuance


State Development Loans (SDLs): Definition and Motivation Behind Issuance

State Development Loans (SDLs): Definition and Motivation Behind Issuance

Are you looking for an investment option that combines stability and lucrative returns? What if there was a way you could invest and build a prosperous future while also helping out the government? There is a way you can do this: through SDL - State Development Loans.

When State Governments require funds, they issue State Development Loans. This creates an opportunity for investors and provides a stable source of returns. Let's dive into the world of State Development loans to understand what they are and determine if SDLs are the right investment choice for you.

What are State Development Loans?

State Development Loans, or SDLs, are bonds that state governments issue to meet budgetary needs. This means that when state governments face fiscal deficits, they need additional funds to meet budgeted expenditures. In such cases, bonds called ‘State Development Loans’ are issued so the government can generate funds.

State governments borrow money through SDLs from insurance companies, pension and mutual funds, and retail investors. Investing in SDLs means you receive interest payments at half-year intervals and the principal amount when the bond matures.

State Development Loans are issued through and monitored by the RBI. The Reserve Bank monitors timely interest and principal payments. Most SDLs are issued for a tenure of 10 years. SDLs are issued in primary markets through RBI auctions and can also be traded in the secondary market.

Why are SDLs issued?

The primary reason for a state government to issue an SDL is to meet the gaps in their revenue and expenditure. This helps state governments fund various development projects without financial dependence on the central government. SDLs facilitate fiscal autonomy, which allows state governments to allocate appropriate funds to regional development, debt management and public welfare.

How do you invest in SDLs?

Until recently, investing in SDLs was open only to prominent players such as businesses, insurance companies, mutual funds, and pension funds. However, it is now possible for retail investors to invest in state development loans. This means that as an individual, you have two avenues through which you can partake in the benefits SDLs offer.

#1 RBI Auctions

Now, it is possible for retail investors to also participate in State Development Loan auctions conducted by the RBI. 5% of the total borrowing amount of an SDL is reserved for retail investors. You need a Retail Direct Gilt (RDG) account with the RBI to participate in this auction.

You can create an RDG account online under the RBI Retail Direct Scheme. The RDG account also gives you access to the NDS-OM security market, where government securities are traded.

Through an RDG account, you can choose the SDL bond you wish to invest in, and the investment is made for a tenure of 10 years. The minimum investment amount through RBI auctions of SDL bonds is Rs. 10,000 or multiples of it.

Investing in State Development Loans is free of charge. However, you must consider that exiting the bond prematurely may not be straightforward. It is also essential to note that the income you receive from SDL investments through the RDG account is taxable.

#2 Target Maturity Funds

Target Maturity Funds (TMFs) are a type of maturity-focused fixed term Exchange-Traded Funds (ETFs). It provides investors with structured investment plans as they mature within a predetermined time frame. 

When you use a TMF to invest in a State Development Loan, you get access to a wide range of SDLs, reducing your investment's overall risk.

TMFs have relatively shorter maturity periods, usually four to five years, compared to the ten-year tenure when investing through an RBI auction. TMFs have a lower minimum investment amount compared to RDG account investments.

While RDG account investments may provide a higher State Development Loan interest rate, the TMF route offers ease of exit. Similarly, the 0.15% expense ratio you are charged for your investment is offset by the 20% tax with indexation benefit that some TMFs offer.

Advantages of investing in SDLs

#1 Lower Risks

State Development Loans are backed by an implicit sovereign guarantee, which makes them highly safe investment options. Additionally, SDL bonds are issued, auctioned and monitored by the RBI, making them reliable and a good investment opportunity for new investors.

#2 Higher Returns

SDLs offer higher returns when compared to other debt securities, which makes them an attractive investment option.

#3 Stable source of income

State Development Loans pay interest at half-year intervals, which gives you access to a stable and reliable income source.

Risks of investing in SDLs

#1 Liquidity Risk

While SDLs are more liquid than most other debt securities, exiting an SDL bond before maturity may still be tricky. This is because, in some instances, it is difficult to trade an SDL in the secondary market.

#2 Credit Risk -H3

While the RBI monitors SDL bonds and the bond has implicit sovereign guarantees, there is still some risk of interest not being paid. This might happen if the State lacks good financial health and lags in fiscal budget targets.

#3 Interest Rate Risk

There is an inverse relationship between bond prices and State Development Loans interest rates. This means that if the interest rates go up, the yield of your SDL bonds may go down. You can avoid the interest rate risk by committing to long-term investments.

To sum up

State Development Loans are considered to be relatively safe and reliable investment options. However, it is best to consider various aspects before choosing the SDL and the investment strategy you wish to commit to. Carefully evaluate market conditions and the State's financial health. Similarly, define your risk tolerance, the tax implications you face, and the investment tenure that suits your preferences.

In today's world, there is a plethora of investment options to help you grow your wealth. At Tata Capital, we streamline and bring all these investment opportunities to you through a single platform. Additionally, our experts hold your hand and guide you in choosing the right investment strategy for your financial needs.

To explore our services and start your investment journey, visit the Tata Capital website today!

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