All investors know that government bonds G-Secs (G-Secs) have an explicit government (sovereign) guarantee. Many investors ask if state development loans (SDLs) are also guaranteed by the government of India. Unlike G-Secs, state development loans have an “implicit” sovereign guarantee. That means, if the fiscal situation of a state were to deteriorate to the extent that they are unable to make interest payments on SDLs, it’s assumed that the central govt and the RBI would step in to ensure bondholders are paid back.
Shaktikanta Das, the RBI governor, answered this exact question in a press conference in 2019:
Anup Roy Business Standard: Sir, state development loans, it is a very risky thing, FPIs don’t touch it, many investors don’t want to touch it. And now through stock exchanges you are encouraging retail investors to invest in it. So, don’t you think it is risky, because retail investors don’t know about the fiscal situation of states?
Shaktikanta Das: You see, the state development loans, as they are known, that is the borrowing by the state governments are not risky at all. Because there is an implicit sovereign guarantee in them. First thing is that the state governments are sub-sovereign. The second thing is, there is an implicit debit mechanism through which RBI operates, on the due date of repayment the RBI automatically debits the state government account and makes the repayment. So, therefore, there is an implicit sovereign guarantee so far as the state government loans are concerned. So, therefore, they would not and they cannot be considered as risky. And this position has been accepted also by the Bank for International Settlements.