Should You Invest In State Development Loans?

State Development Loans (SDLs), which are bonds issued by State governments in India, present a secure investment avenue for fixed-income investors who prioritise capital protection. These bonds typically offer yields that are 25-50 basis points higher than Central government securities and come with an implicit sovereign guarantee.

Retail investors can now access SDLs via the RBI Retail Direct platform, which was launched in November 2021. During this period, retail investors purchased government bonds worth ₹6,208 crore through primary market subscriptions and traded ₹1,723 crore in the secondary market. They acquired SDL bonds worth approximately ₹430 crore.

Given the availability of other government-backed investment options offering higher yields, it is essential to evaluate how SDL bonds compare. Let’s explore their key features, investment avenues, and the strategic role they can play.

Risk-free investments

SDL issuance has surged post-Covid, reaching ₹10 lakh crore in 2024, with most states actively participating. As of March 2025, SDLs constituted one-third of the government securities market, with bonds worth ₹62 lakh crore outstanding. Commercial banks, insurance firms, and provident funds hold 85 per cent of these bonds, while mutual funds account for about 2 per cent, investing ₹1 lakh crore.

SDLs work similarly to central government securities but are designed to meet State-level financing needs. They’re issued through RBI-conducted auctions with maturities ranging from two to 40 years, with interest paid semi-annually. The interest income is taxable as per the investors’ tax slab.

These investments are considered risk-free, as the RBI has an escrow mechanism to ensure timely payments. In the event of default the sums will be paid and adjusted against funds owed to the respective State by the Central government. But there is no known case of SDL default by a State government so far.

How to Invest

The RBI Retail Direct platform allows investors to participate in G-secs, including SDL, with a minimum investment of ₹10,000 in the non-competitive segment of primary auctions. Additionally, it facilitates buying and selling SDLs in the secondary market. Other investment channels include banks, primary dealers, BSE Direct, NSE goBID, brokerage firms, and online bond platforms.

The RBI Retail Direct platform offers a seamless and cost-effective investment process. Retail investors can open a Retail Direct Gilt Account by submitting their PAN and Aadhaar details and completing KYC verification through the official website. Registered users gain access to the primary issuance portal and NDS-OM for secondary market transactions. The platform charges no fee for account opening, maintenance, or bid submission. RBI conducts SDL auctions every Tuesday, with the list of available bonds announced quarterly on its website.

However, retail investors may face challenges in the secondary market due to limited liquidity. Hence, it is advisable to buy SDLs only with a buy-and-hold approach until maturity.

Investing through mutual funds (MFs) offers a convenient pathway for investors. MFs periodically introduce Target Maturity Funds (TMFs) to capitalise on opportunities in the government securities market. They invest either in SDLs or a mix of SDL, G-Secs, and PSU bonds. TMFs are passive funds with predefined maturities, typically ranging from three to five years. Returns generally align with the Yield to Maturity (YTM) if investors remain invested for the entire duration. TMFs are structured as either index funds or exchange-traded funds (ETFs), allowing investors the flexibility to buy or sell units throughout the fund’s tenure.

The expense ratio associated with TMFs can impact returns. As of February 2025, the average expense ratio for regular plans of TMFs stood at 0.4 per cent, whereas direct plans had a lower expense ratio of 0.2 per cent.

Should you invest?

The fiscal health of State governments is a crucial factor to consider when investing in SDLs. Inter-State spreads have emerged due to fiscal concerns in certain States, leading to slightly higher yields for their bond issuances. Large investors typically favour SDL from States with stronger fiscal positions such as Maharashtra, Gujarat, and Tamil Nadu.

SDLs have historically offered yields ranging from 6.5 to 7.5 per cent, which are 25-50 basis points higher than those of Central government securities. Over the last six months, SDLs were issued with yields ranging from 6.75 to 7.34 per cent. For instance, within bonds issued with a tenure close to 10 years, States such as Gujarat, Andhra Pradesh, and Tamil Nadu issued SDLs with lower yields close to seven per cent, while Assam, Chhattisgarh, and Nagaland issued bonds with higher yields close to 7.3 per cent. Meanwhile, the India 10-year G-sec yields traded between 6.6 per cent and 6.9 per cent during the period.

When comparing SDL to other government-backed investments, RBI Floating Rate Savings Bonds offer a higher annual return of 8.05 per cent. Small savings instruments like the National Savings Certificate (7.7 per cent) and Senior Citizen Savings Scheme (8.2 per cent) provide even more competitive rates. Additionally, bank fixed deposits with insurance coverage up to ₹5 lakh often give higher returns than SDLs.

Given these factors, SDLs are most suitable for conservative, long-term investors who prioritise capital safety and prefer a buy-and-hold strategy. Their implicit sovereign guarantee and relatively stable yields make them a reliable option for risk-averse investors.