Are state guarantee bonds really secured?

Bonds
1

Most of us when invest in bonds care about our principal ( amount initially invested in the bond).

Bonds that are backed by the sovereign are considered the safest bonds out there, this is because if the bond fails that means the country gets bust and if the country gets bust you automatically lose all your money anyway.

However one needs to understand the difference between sovereign bonds and state guaranteed bonds. Most people think these bonds are safe since they are backed by the state but one needs to understand that there is a thin line between these bonds.

Sovereign bonds usually consider

  1. Government securities which are issued by the RBI on behalf of the central government.

  2. State Development Loans which are issued by the state government to raise funds for development. It allows people to invest in the particular development of a state.

These bonds are backed by the sovereign so chances of default are less than 1 % .

Yield on many of these bonds range from 7 to 7.5%

However state guaranteed bonds are not backed by sovereign directly.

Many of these bonds have yields which are far higher than the market rates. For example, UP Power Corporation Bonds of 2025 maturity are trading at 10-11%, while Andhra Pradesh Capital region development Bonds with 2025 maturity are being offered at 9%.

These bonds seem attractive to many people since they are high yielding and are seen as state backed. Every time a bond offers you a high interest you need to research it deeply. There is a reason these bonds offer high interest rates and it is due to their weak balance sheet.

In 2019 the rating of Bengaluru Metropolitan Transport Corp. (BMTC), a state government PSU, was downgraded by ICRA to D (default) on account of delays and irregularities of payment. Though BMTC only had bank facilities it still affects their borrowing power.

Taking examples of another state guaranteed bonds like

  1. Andhra Pradesh capital region development authority bond, the bond currently offers a yield of 10.8% much higher than bank FD’S and even some mutual funds. However the state has a weak economic structure with secondary sector contributing less than the primary sector . GST collection was impacted which reduced its ability to service interest obligations thereby requiring a loan of 3200 crores by the Government of Andhra Pradesh.
  2. Uttar Pradesh Power Corporation Limited Although the bond seems to be better than the Andhra Pradesh capital region development authority bond it still has its own disadvantages. The most prominent one being the low per capita income in Uttar Pradesh. Not meeting targets set by the corporation. Increase in debt guarantee from 42 to 48%. These bonds however put as high as 20 crore in an escrow account daily to service these debts. Also the new Atmanirbhar Bharat scheme provides them with significant packages which increases its liquidity

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1 Like
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Nope - they are not explicitly guaranteed by central government. Thats why they yield higher than G-Sec and hence all MF fund managers happily pack them into their debt portfolios. However, only in the case when one of the states defaults on their SDL obligation we will know the true risk. If the centre steps in - then we know its secure - else it will wipe out years of yield collected.

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Is there a case for looking at the top contributing states to GDP? - wrt SDL

4

By reading credit reports andhra pradesh is actually at a risk

But the GoAP has always stepped in to help them

5

@VijayNair : No I think we need to look at state finances for their ability to fund debt obligation. Looking at GDP contribution would ignore their debt obligations I think.

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Has any state delayed / defaulted on its SDL ever ?
Any suggestions/ references to find more about this aspect?

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Nope. None ever.

8

SDL gives a higher yield, but if you plan to step into trading - then GOI bonds better.

9

For retail investors - trading in bonds is a very illiquid option. Most of bond trading happens offline over phone calls etc. Old style. Across the world.

10

I am referring to FnO trading using collateral pledge.

11

Ah - yes … got you. Yes you can pledge Gsec for margin.

12

Currently, no Indian state has defaulted on any of the bonds, so only when that happens will one truly know what happens. Estimates are there that the central government will step in and save the state, but until that happens, it is just a guess.

13

nope, central bank would make people pay with inflation :stuck_out_tongue: . These methods were already used by weimar germany, hungary , Zimbabwe , yugoslavia etc

14

@raoawesome

Yes the inflation will increase but these SDLs will still pay higher than the inflation rate. :wink: