State bond yields harden on heavy supply and weak investor demand

14 states raised Rs 50,500 crore through bonds at the auction

Heavy supply at the weekly state government bond auction on Tuesday coupled with weak investor demand pushed the yields on state bonds higher. The cut-off yield on those bonds ranged between 7.22 per cent and 7.34 per cent, against 7.17 per cent to 7.20 per cent in the previous week.

 

Fourteen states raised ₹50,500 crore through state bonds at the auction. In the previous week, 17 states had raised ₹41,054 crore.

 

The yield spread between the benchmark 10-year government bond and 10-year state bonds widened to 47-48 basis points (bps), from 30-35 bps in the previous week.

 

The benchmark 10-year government bond yield settled at 6.75 per cent on Tuesday, against 6.74 per cent on Monday.

 

Market participants said there was heavy supply and a lack of demand because of factors like outflows from Life Insurance Corporation (LIC) due to policies maturing, and banks not buying aggressively owing to liquidity issues.

 

“The yield spreads, which were around 30-35 bps, have now increased to 47-48 bps. Last two-and-half years, the spreads have remained at levels of about 30 bps,” said Anshul Chandak, head of treasury at RBL Bank.

 

“This shift is due to heavy supply and a lack of demand. LIC is experiencing significant policy redemptions this month, leading to reduced net buying, while banks have been less aggressive in their purchases due to liquidity constraints at year-end. As a result, the spreads have widened,” Chandak said.

 

Market participants noted that corporate bond yields were slightly up on Monday in the secondary market and are expected to rise further in the upcoming primary issuance, as markets typically re-price after a new primary issue. 

 

“This will certainly trickle down to corporate bonds,” said a dealer at a state-owned bank. “The low liquidity is the reason for caution,” he added.

 

The net liquidity in the banking system was in a deficit of ₹1.09 trillion as of Monday, according to the latest data by the Reserve Bank of India (RBI). The same has been in deficit mode for the past 11 consecutive weeks.

 

In the last quarter of the previous financial year (Q4FY24), a similar surge in supply of state bonds was absorbed due to strong investor demand.

 

Venkatakrishnan Srinivasan, founder and managing partner, Rockfort Fincap LLP, said: “Rewind to the same period last year when similar supply surges were comfortably absorbed, thanks to strong investor demand. Fast forward to today, and the landscape has changed. A confluence of tight liquidity conditions, rupee weakness, and escalating US trade tensions is exerting upward pressure on yields, which has resulted in wider SDL (state development loans) and corporate bond spreads over the risk-free benchmark, signalling investor caution.”

 

On the other hand, corporate bond supplies have also picked up in recent weeks. After January’s bond market turmoil, triggered by geopolitical events, large-ticket issuers are rushing to raise funds now that the RBI’s policy decision and the FY26 Union Budget are out of the way.