Heavy Supply Reverses Trend; 15-Year State Bond Yields Rise Above AAA Corporate Bonds

A heavy state borrowing programme has kept 15-year state government securities at a premium to comparable AAA-rated corporate debt, with the narrow investor base adding to the pressure, despite abundant banking liquidity.

Fifteen-year state bonds issued in August fetched yields of 7.59-7.65%, compared with 7.49-7.55% for 15-year bonds issued by REC Ltd, NABARD and Power Finance Corp. The premium ranges from 4 basis points to 16 bps, depending on the state and PSU issuer.

State bond cut-off yields have historically settled below coupons on comparable-tenure AAA-rated corporate bonds, data compiled from primary issuances since 2022 show, as investors have typically demanded a smaller premium to hold state government paper than public-sector corporate debt.

The yield advantage has varied across issuers, ranging from 1-2 basis points in cases such as PFC's November 2022 and REC's November 2022 bonds, to substantially wider spreads against corporate issuers including Adani Ports, ICICI Bank and Punjab National Bank. The differential underscores the pricing advantage that state government securities have typically enjoyed over comparable-tenor AAA corporate bonds. While exceptions have occurred, they remain isolated instances rather than a sustained trend.

That pattern broke down in 2026, with 15-year SDLs issued in August yielding 7.59%-7.65%, above the 7.49%-7.55% offered on comparable AAA-rated bonds. The reversal has been attributed to heavy state borrowing supply.

States are estimated to raise 8.8-9.7 trillion rupees through net state government securities issuance in 2026-27, creating a sizeable amount of paper that must be absorbed by a relatively concentrated pool of long-duration investors.

The supply pressure is particularly relevant at the long end of the curve, where state government securities depend more heavily on insurers, provident funds and other investors with long-duration liabilities. A large issuance pipeline can require states to offer higher yields to attract buyers, especially when several issuers access the market around the same time.

“For a few large institutes viz insurance and pension funds, there are mandatory investment requirements, an investment pattern that has to be adhered to,” said Vinay Pai, Head of Fixed Income at Equirus Capital.

AAA corporate bonds, by contrast, can tap a broader investor base that includes banks and mutual funds, in addition to long-duration institutional investors. An established issuer such as REC or PFC can therefore attract demand at a lower yield, while a state bond may need to offer an additional spread to bring investors in at the margin. Banks also typically do not park as much money in longer-dated state securities.

“The short supply in corporate bonds has led to yields of these bonds below certain SDLs of similar tenure,” Pai added.

Investor base
The divergence comes despite banks having additional funds to deploy following the Reserve Bank of India's FCNR(B)-related inflows. Banks' demand is concentrated in assets that fit their duration, regulatory and risk requirements. As a result, additional liquidity in the banking system does not automatically translate into stronger demand for long-dated state bonds.

The mismatch highlights how liquidity in the financial system does not necessarily translate into uniform demand across the bond market. Long-dated state government securities remain more reliant on a narrower pool of institutional investors, while PSU bonds benefit from a deeper and more diversified buyer base.

“It is purely a demand-supply dynamic that is being played out. Insurers and pension funds have a specific quota that they have to invest in longer-tenure AAA bonds,” said Pratik Shroff, fund manager – fixed income at LIC Mutual Fund. “And one doesn’t see much issuance in that segment. So, whatever is coming in the market, is probably being lapped up.”

Credit fundamentals
The yield differential also reflects differences in underlying credit fundamentals across issuers. For states, investors look at indicators such as debt-to-GSDP, fiscal deficits and the sustainability of borrowing programmes. For PSUs, leverage, balance-sheet strength and the extent of government support are key considerations.

The states that have borrowed through the 15-year papers in August include Bihar, New Delhi, Gujarat, and Tamil Nadu. At the budget level, Tamil Nadu plans to borrow around 1.73 trillion rupees, Gujarat around 1.00 trillion rupees and Bihar around 619.39 billion rupees through state government securities in FY27. Delhi has also entered the market with its first-ever state bond borrowing this year, adding another issuer to the supply pipeline.

As for the corporate books, as on June 30, PFC has a reported debt-to-equity ratio of around 5x, compared with 5.5 for REC. NABARD is wholly government-owned, supporting its strong sovereign-linked credit standing.

For investors able to hold long-duration paper, the premium on state government securities offers additional carry over comparable PSU bonds. But the higher yield also compensates for the narrower buyer base and potentially lower liquidity of long-dated state debt.