State Government Securities (SGS), formerly known as State Development Loans (SDLs), have been drawing attention lately. The yield spread between SGS and Central government securities (G-secs) has widened to around 100 basis points (bps) in recent months, presenting an attractive opportunity for investors seeking safety with consistent income. Traditionally, this gap hovered between 25 bps and 50 bps.
In the latest RBI auction held on October 28, the weighted average yield on newly issued SGS ranged from 6.97 per cent to 7.44 per cent for securities maturing between 6 and 30 years. The 10-year SGS traded at a spread of 62–69 bps over the 10-year G-sec benchmark, which itself yielded 6.54 per cent during the day. Simply put, the spread represents the yield difference between SGS and G-secs of the same maturity.
SGS are issued by State governments in India and function similarly to central government securities but they are designed to meet State-level financing needs. They are auctioned through the RBI, with maturities ranging from two to 40 years and interest paid semi-annually. The interest income is taxable as per the investor’s income tax slab.
These investments are considered virtually risk-free, as the RBI maintains an escrow mechanism to ensure timely payments. In the unlikely event of a default, the dues are adjusted against funds owed to the respective State by the Central government. Notably, there has never been a recorded instance of an SDL default by any State government so far.
Why the spread widened
The rise in SGS yields and their wider spreads over Central government bonds in recent months have been driven by supply pressures, shifting market sentiment, and borrowing patterns. States have been issuing longer-tenure bonds — typically 15 to 30 years — to push repayment obligations further into the future. In the second quarter of FY26, State borrowings touched ₹2.99 lakh crore — about 105 per cent of the budgeted amount and 26 per cent higher than a year ago. Telangana, Kerala, and Himachal Pradesh were among those issuing ultra-long papers maturing beyond 20 years. This heavy supply of long-tenor papers prompted investors to demand higher returns, pushing yields upward.
According to Venkatakrishnan Srinivasan, Founder and Managing Partner at Rockfort Fincap LLP, banks have grown cautious about holding too many long-dated securities, while corporate bond issuance has dropped sharply, shrinking investment options and concentrating demand in sovereign and sub-sovereign papers. The Centre’s front-loaded borrowing also left States competing for funds later in the year, further widening spreads. Though fiscally weaker States contribute marginally to investor caution, SGS remain virtually risk-free as they are serviced by the RBI. The result has been a structurally higher premium, reflecting both supply imbalances and compensation for duration risk.
In the September 2, 2025 auction, the spread peaked at 109 basis points for 10-year SGS and 117 basis points for maturities above 20 years. However, spreads have since narrowed as States curtailed borrowing and moderated new issuances. The reduced supply revived demand, lifting prices and lowering yields by 30–40 basis points. This restraint, particularly in October, helped ease market pressure and stabilise spreads.
Looking ahead, yields are likely to soften gradually. The third-quarter SGS borrowing calendar, at ₹2.88 lakh crore, marks a 2 per cent reduction from Q2FY26 and 12 per cent lower than Q3FY25. A potential 25 basis-point RBI rate cut in December 2025 could bring 10-year yields closer to 7 per cent, narrowing spreads further. With seasonal demand from insurers and pension funds set to rise in the January–March quarter, the outlook points to a steady easing in yields and a more balanced spread in the months ahead.
What should you do?
SGS offer a safe and reliable avenue for fixed-income investors who prioritise capital protection. Retail investors stand to benefit, as SGS combine sovereign-level safety with yields higher than comparable bank deposits or Central government bonds. Investors can align their SGS investments with their financial goals and time horizons. For instance, in the latest auctions, SGS maturing in 6–9 years yielded 6.9–7.1 per cent, above the 6.05 per cent offered on SBI’s 5–10 year deposits and close to 7.05 per cent for senior citizens.
The fiscal strength of individual States also matters. Inter-State spreads have emerged as fiscally weaker States offer slightly higher yields to attract buyers. For example, Tamil Nadu’s latest 10-year SGS fetched 7.15 per cent, while Sikkim’s reached 7.22 per cent. Institutional investors usually prefer bonds from fiscally stronger states such as Maharashtra, Gujarat, Tamil Nadu, Karnataka, and Telangana.
With the RBI’s Retail Direct platform, investors can now access SGS directly without intermediaries, starting with a minimum investment of ₹10,000 in primary auctions. The platform also enables trading in the secondary market. Other investment routes include banks, primary dealers, NSE goBID, BSE Direct, brokerage houses, and online bond platforms. Mutual funds offering gilt schemes that invest in SGS are another convenient option.
When compared with other government-backed products, RBI Floating Rate Savings Bonds currently offer 8.05 per cent annually, while small savings schemes such as the National Savings Certificate (7.7 per cent) and the Senior Citizen Savings Scheme (8.2 per cent) offer slightly higher returns.
With States moderating borrowings and a potential RBI rate cut on the horizon, investors entering now may benefit from both stable income and potential capital gains as yields decline.
Published on November 1, 2025
