Mumbai: Credit rating may deepen the state development loan (SDL) space, an institutional driven segment with an illiquid secondary market, a report by India Ratings and Research (Ind-Ra) said here today.


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State development loan issuances and appetite has shown a rise as evident from the recent interest of foreign portfolio investors (FPIs).


Ind-Ra, however, believes that the inter-state disparity in the quality of finances, transparency, outstanding guarantees and overall states' health should have implications for state-level bond pricing and investor interest despite it being categorised with a zero risk weightage by the RBI.


This would necessitate the states to be differentiated on the credit curve, which in Ind-Ra's view would help in deepening the market.


Investor appetite for SDLs has increased, with the market size at Rs 1.35 trillion (close to 11 percent of GDP), annual gross issuance has increased around threefold in the last four years to around Rs 250 billion in FY15 (from Rs 100 bn in FY11), the report said.


SDLs on an average had a spread of 37 basis points (bps) over the government security in FY15 (from 70 bps in FY11).


While some of it is on account of liquidity premium, the remaining part could possibly be on account of credit risk.


Interestingly, the spreads remain range-bound across states irrespective of their fiscal position, it said.


Interest expenses singularly formed 10.7 percent of the states' total revenue expenditure for 2014-15.