Mumbai Capital

SDL: State preferred choice for investments

Maharashtra, followed by Andhra Pradesh, Tamil Nadu and Gujarat will emerge as preferred choice for investments in State development loans (SDLs), according to India Ratings and Research (Ind-Ra), a Fitch Group company.

“We find Maharashtra SDLs rank the best among the states when it comes to the trading of bonds,” said Ind-Ra in a report titled State Development Loans: Differentiation Theme To Be Key . “Notwithstanding the size and frequency of their issuances, appetite for Maharashtra SDLs is strong.” The report finds Bihar is at the other end of the spectrum due to limited market activity as compared to the other State bonds.

Based on the liquidity score, the wide divergence in market activity of SDLs is not fully reflected in their spreads and as a result, Ind-Ra believes, spreads are set to widen hereon even as fundamental credit quality will have its implications.

“In our previous analysis on SDLs, we suggested that credit differentiation could provide depth to the SDL market. In furtherance, we have studied the market activity of SDLs and isolate its likely impact on spreads. A caveat to bear in mind is that the fiscal performance and credit quality of States will have an impact on SDL performance in the longer term,” said the report.

SDLs are treated more as a generic asset class, with investors making limited differentiation among the qualities of States’ performances. This has skewed market dynamics and bunched up inter-State spreads of most SDLs at a point in time in the range of +/-5 basis points.

Ind-Ra’s ranking mechanism seeks to quantify the differences in the liquidity of SDLs and has arrived at states’ rankings based on the market activity of the top 15 issuer states.

The comparator assigns a combined ranking to the states based on their primary and secondary market activities (see chart), with rank 1 indicating higher market liquidity. Despite the wide range in market performance of SDLs, their average spreads have tightly hovered in the 39-44bp range barring Telangana.

A shift from the buy-and-hold investor base to a more diverse set of investors will take this aspect into consideration and eventually, States with better liquidity scores are likely to command finer premiums, said the report.

Tamil Nadu, despite being ranked A, pays the lowest spread on an average, as its ranking of SDLs fare better than most other States, said the report. It said that similarly Punjab pays a lower spread than some of its better-rated peers on back of a better liquidity ranking.

With the spreads themselves are ranging in a tight band, the inter-State differential of economic performances has not manifested in the interest costs the States pay for their market borrowings.

Therefore, Ind-Ra, in its report, opines that pricing in the SDL market is likely to be less generic with the diversification and deepening of markets and focus more on both the credit quality and liquidity of states.

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Printable version | Jan 16, 2022 2:31:15 PM |

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