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With better returns in sight, investors bet on state bonds

Monthly trade volumes in the secondary market for bonds have jumped 53 per cent in the past year.

, ET Bureau|
Updated: Nov 03, 2015, 04.21 AM IST
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Monthly trade volumes in the secondary market for bonds have jumped 53 per cent in the past year.
Monthly trade volumes in the secondary market for bonds have jumped 53 per cent in the past year.
MUMBAI: Investors have been barely interested in securities and bonds floated by state governments, a perception that’s fast changing as financials of some states are looking healthier than that of the central government.

Trading volume has soared as yield-chasing investors are loading up on state bonds, or state development loans (SDL), as known in market parlance. The market share in proportion to sovereign securities has more than doubled since July this year, according to a market estimate.

The secondary market monthly trade volumes jumped 53% in the past year. In the first six months of this fiscal, the monthly average volume is at Rs 23,106 crore against Rs 15,769 crore in FY15, show data provided by Edelweiss Financial. With better returns in sight, investors bet on state bonds “Liquidity in SDL trading has also improved, with a wider set of investors buying these papers,” said Saugata Bhattacharya, chief economist at Axis Bank. “Although there are pros and cons of higher debt, the spread of state government papers over the Centre’s has narrowed, and states will, in theory at least, be subject to greater market discipline.”

States including Tamil Nadu, Maharashtra, Gujarat, West Bengal offer higher rates than the central government bonds, now yielding about 7.60% half yearly. The spread, or gap, between state and the benchmark government bond yields is also narrowing to about 40 basis points compared with 60-70 bps six months ago.

It was as high as 80-100 bps one-two years earlier, which reflects the rising demand. Bond yields and prices move in opposite direction.

“Along with foreign portfolio investors (FPIs), domestic institutions like mutual funds, banks, pension funds seem to be active nowadays in the state bond market as these securities offer higher

rates,” said Ajay Manglunia, head, fixed income, Edelweiss Securities. “With improving financial health than earlier, investors are increasingly betting on SDLs.”

Earlier on September 29, the Reserve Bank of India had created a separate investment category for FPIs in SDLs.

After a change in the investment pattern, PFs now have more elbow room to invest in SDLs of up to 45% of their portfolio against 15% earlier. They are investing more to attain higher rate as they are mandated to generate 8.75% return annually.

“In pursuit of returns, many provident funds are now drifting towards SDLs,” said Amit Gopal, senior vice-president, India Life Capital.

Over the past two years, the states’ borrowing mechanism has been streamlined with regular auctions held every alternate Tuesdays. Seven to 14 states borrow Rs 8,000-16,000 crore in each auction. For the first time, the RBI has issued a tentative calendar for selling state securities in line with central government bonds.

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