State governments are likely to return aggressively to the bond market in the final quarter of FY26, even as investor demand remains subdued and revenue collections slow. According to a research note by IDFC First Bank, gross state development loan (SDL) issuance in Q4FY26 could rise to nearly Rs 4.5 trillion, making borrowing plans a key near-term risk for the bond market amid weak demand from banks, insurers and pension funds.
Here are the five key takeaways from the report:
Q4FY26 borrowing is set to rise sharply
According to the report, state governments are expected to issue Rs 4.5 trillion worth of bonds in Q4FY26. For the same quarter last year, the figure was Rs 4.3 trillion. The borrowing calendar could be even higher at Rs 4.9 trillion. For the full year, gross SDL issuance is estimated at Rs 11.9 trillion, compared with Rs 10.7 trillion in FY25.
Tax revenue growth has slowed significantly
Tax collections across 17 states are growing at just 8.9% year-on-year in FYTD26 (till October), sharply lower than the 15% growth recorded a year earlier. The slowdown is visible both in states’ own tax revenues and their share of central taxes, largely reflecting softer nominal GDP growth and the early impact of GST rate cuts, the report added.
Declining central grants are adding to fiscal stress
Grants from the Centre, including finance commission transfers and centrally sponsored scheme funding, have fallen 21.4% year-on-year so far in FY26, after a 19.4% decline last year. The report mentions that this is due to the discontinuation of GST compensation sharing and tighter cash management done by the centre.
Fiscal deficits are under control due to spending restraint
Despite weaker revenues, the aggregate state fiscal deficit is estimated at 3.3% of GSDP in FY26, only marginally higher than last year. This has been achieved mainly by slowing expenditure growth, which has moderated to 6.2% year-on-year, led by cuts in revenue spending such as subsidies, wages and pensions. Capital expenditure, however, has picked up after being disrupted by elections last year.
Bond demand remains weak despite RBI support
Demand conditions remain challenging, with banks’ investment in government securities constrained by high credit-to-deposit ratios and pension funds shifting more allocations towards equities. Net state bond supply in Q4FY26 is estimated at Rs 3.4 trillion, pushing overall net bond supply higher even after RBI open market purchases.
The IDFC First Bank report cautions that this unfavourable demand-supply balance could keep pressure on yields, especially at the long end of the curve.