KOCHI: Kerala, one of India’s most fiscally stretched states, is beginning to feel the heat of changing market sentiment.
The bond market that once absorbed state borrowings without hesitation is turning selective, driving up yields on State Development Loans (SDLs) and tightening subscription levels.
According to Reserve Bank of India data, total SDL issuances across states in October 2025 fell to about Rs57,000 crore – nearly 50 per cent lower than September – as investors demanded higher yields to absorb new paper.
The bid-to-cover ratios have thinned, signalling that lenders are getting choosier about which state debt to hold.
For Kerala, which depends heavily on market borrowings to bridge its fiscal deficit, this shift could raise the cost of every rupee raised. The state’s debt-to-GSDP ratio hovers near 36 per cent, among the highest in the country, and its interest payments already consume a large share of revenue receipts.
Even a 25-basis-point increase in borrowing costs could translate into hundreds of crores in additional annual interest expenditure.
The state’s market borrowings ceiling for FY26 has been set at 3 per cent of its GSDP, with an additional 0.5 per cent allowed if certain reforms are met.
For the first nine months of the fiscal, the Centre has fixed Kerala’s borrowing limit at Rs29,529 crore. The state has sought additional borrowing of about Rs7,877.57 crore and restoration of deductions of Rs4,288.16 crore.
November tally
As of November 4, Kerala’s total market borrowings stood at Rs30,988 crore, already exceeding the approved limit for the first nine months. Borrowings were frontloaded – about Rs14,000 crore by June-end (Q1) and Rs28,988 crore by September-end (Q2). Most of the bonds issued have long maturities, some extending up to 30 years and more
During the first quarter, the average coupon was below 7 per cent, but it climbed towards 7.5 per cent by September and stayed near that level through November. With investor appetite waning, the state may need to offer even higher rates in upcoming tranches.
Spread widening
The gap between 10-year SDL yields and comparable central government securities has widened beyond 100 basis points – the highest in nearly four years. The spread, once around 40–60 bps, has ballooned as investors demand a premium for state-specific fiscal and refinancing risks.
Banks, which dominate the investor base for SDLs, are liquidating part of their government securities portfolio to fund credit growth amid sluggish deposit mobilisation.
RBI data show that while banks are mandated to hold at least 18 per cent of their net demand and time liabilities in government securities, they traditionally held nearly 10 percentage points more. That cushion is now thinning as credit demand outpaces deposit growth, tightening the market for state bonds.
Kerala’s borrowing programme for FY26 is heavily front-loaded, with large tranches expected through December and January. But the changing market dynamics mean the state will have to pay more to raise funds.
A recent CARE Ratings note warned that Kerala’s debt servicing obligations are growing faster than its revenues, leaving limited fiscal room for capital expenditure.
Unlike resource-rich or manufacturing-heavy states such as Gujarat and Maharashtra, Kerala’s revenue base remains narrow. Its dependence on central transfers and remittances makes it particularly vulnerable to funding shocks.
If investor appetite for SDLs weakens further, Kerala could face both higher borrowing costs and rollover risk on maturing paper.
The broader trend signals a new phase of market discipline. Across states, investors are scrutinising fiscal metrics, off-budget borrowings and spending patterns before bidding at auctions.
For fiscally weaker states, access to the bond market is shifting from assured to conditional – where credibility, transparency and spending quality determine borrowing costs.
Experts suggest Kerala needs to pair fiscal consolidation with proactive investor communication. A clearer medium-term debt roadmap, better alignment of borrowings with productive capital projects, and avoidance of bunching in issuances could help rebuild investor confidence.
