Record borrowing by Indian states at higher yields is set to weigh on the rupee bond market, which may force issuers that have scrapped deals since December to remain on the sidelines as they wait for yields to settle or start paying up to get the deals done, DCM bankers said.
Nine Indian states raised a combined Rs310bn (US$3.4bn) from bonds with four to 30-year tenors on Tuesday at higher-than-average cutoff yields in a 6.95%–7.67% range, according to Reserve Bank of India data. In January 2025, 10 states raised Rs195.25bn from bonds with six-year to 30-year maturities in a 7.01%–7.15% range.
The borrowing is part of a plan by Indian states to sell a record Rs5trn of bonds in this quarter, exceeding market estimates and up from Rs4.6trn in the same period a year earlier, according to an RBI release on January 2.
"The state government bond cutoff yields are significantly higher this year compared with 2025 because of record supply and market expectations of continued heavy borrowing going into next fiscal year, which is reflected in the price, "said Soumyajit Niyogi, director of the core analytical group at India Ratings & Research. "Record gross issuances in the January to March quarter is creating a demand-supply imbalance."
There was a knee-jerk reaction in the bond market after the Reserve Bank of India released the states' borrowing calendar, with government and state-owned enterprise bond yields climbing on expectations of increased debt issuance.
The 10-year government and PSU (public sector undertakings) benchmarks both rose almost 5bp to 6.64% and 7.33% respectively on Monday, according to LSEG data. The yields were seen at 6.61% and 7.33% on Thursday.
If the states stick to their borrowing plan for the quarter, total bond issuance in the fiscal year ending March 2026 will jump 16.8% to Rs12.5trn from Rs10.7trn last year. After accounting for Rs3.7trn in redemptions, net supply is estimated at Rs8.8trn, up 17.1% year on year, according to an Icra note this month.
The states may continue to borrow record amounts into the next fiscal year.
"The states are likely to borrow more than Rs12.5trn in FY27 on the back of a sustained capex push, changes in new fiscal rules and support for social schemes," Niyogi said.
The cutoff yields for state government securities with tenors of 10 years and above are currently about 40bp–50bp higher than a year ago.
For example, the northeastern state of Assam sold 10-year bonds at 7.57% on Tuesday compared with 7.15% on January 7 last year, RBI data showed.
"More importantly, the spread between state government securities and AAA-rated PSU benchmark bonds has widened to nearly 30bp, from just 1bp–2bp a year ago," said Venkatakrishnan Srinivasan, founder of fixed income advisory firm Rockfort Fincap. "This clearly indicates that yields on state government securities have moved up sharply relative to comparable AAA-rated bonds."
Crowding out
The higher yields on state bonds may crowd out public sector issuers and AAA rated corporates.
"State government bonds are an ideal substitute for sticky long-term investors like provident, pension and insurance firms, as they would prefer state government bonds compared with AAA PSU bonds as they get higher returns, although state government securities are illiquid," said Niyogi at India Ratings.
"The provident and pension funds will chase state government bonds, leaving corporate issuers sidelined," said a DCM banker. "We have already seen five deals scrapped since the RBI policy [decision] as yields climbed 20bp across the curve post policy [decision]."
Power Finance Corporation, Small Industries Development Bank of India, Indian Railway Finance Corporation and National Bank for Agriculture and Rural Development have withdrawn planned bond sales of a combined Rs295bn since the RBI's policy announcement on December 5. PFC has scrapped deals twice since the central bank's announcement of a repo rate cut of 25bp to 5.25% and liquidity infusion measures, which have been insufficient to compensate for capital outflows from foreign portfolio investors.
According to market sources, Sidbi will seek bids again on January 12 for Rs80bn of long three-year bonds.
"The public sector companies that have withdrawn issuances in anticipation of yields coming down unfortunately will have to end up paying more when they hit the market," said Srinivasan at Rockfort Fincap.
On December 24, the RBI announced open market purchases of government bonds totalling Rs2trn in four tranches and a US$10bn three-year USD/INR buy-sell swap, after announcing a Rs1trn open market operation purchase and a US$5bn USD/INR swap earlier in the month.
"The end of the rate-cutting cycle is a major worry, and on top of that, there is large state government bond borrowing," which is spooking the markets further, said a second DCM banker.
Some market participants believe the RBI needs to buy state government bonds. "The RBI will have to conduct OMO of state government bonds in higher amounts to cool the yields on these securities," Niyogi at India Ratings said.