The spread between central and state government securities has narrowed from its peak, driven by increased investor participation. The latest state development loan (SDL) auction received stronger-than-expected demand, said market participants.
While the spread can down from 78 basis points to 72 — down six basis points in the past week, the spread has fallen by 13 bps from its peak of 85 bps in January. In the latest auction on March 2, the cut-off yield on the 10-year SDL (state development loans) for Gujarat was 7.40%. For comparison, Tamil Nadu’s cut-off yield stood at 7.54% on February 10.
Subdued investor demand
The spread were elevated due to higher issuances and subdued investor demand. The usual spread between G-sec and state government securities ranges from 30 to 40 bps.
“Long-term investors are driving demand due to attractive spreads over G-secs, while mutual funds eye tactical bets on spread compression,” said a head of fixed income at a mutual fund.
“The SDL spreads have widened as anticipated; however, mean reversion has now begun. With the RBI actively injecting liquidity, conditions are favorable for spreads to tighten. The central bank is believed to have bought securities in the secondary market last week, providing additional reassurance to market participants,” said Abhishek Bisen, head of fixed income at Kotak Mutual Fund.
Elevated state supply
Elevated state supply has pressured central government securities, keeping yields high despite a 125 bps rate cut. Persistent demand-supply imbalances, expectations of no further cuts, and the government’s FY27 gross borrowing announcement of Rs 17.2 lakh crore continue to weigh on the market. The yield on 10-year benchmark paper ended at 6.68% on Monday.
States planned to raise funds to the tune of Rs 5 lakh crore in the fourth quarter. During the same period last year, states borrowed Rs 4.3 lakh crore. So far in the quarter, they have borrowed Rs 3.25 lakh crore.