A Secure Guide To Investing In Indian Government Securities

Investing in government securities in India is a great option for those looking for a stable and relatively low-risk investment. Government bonds, also known as sovereign bonds or treasuries, are debt securities issued by the national government to raise funds for various public spending needs. These bonds are considered safe investments as they are backed by the government, and the risk of default is almost non-existent. In India, government bonds can be purchased through banks, post offices, brokerage houses, gilt mutual funds, ETFs, RBI Retail Direct, and NSE goBID/BSE Direct. The minimum investment amount for a government bond varies depending on the type of bond selected, but most bonds have a low minimum investment limit, making them accessible to a wide range of investors.

Government bonds vs. treasury bills

Overview

Government bonds and treasury bills are both types of government securities, but they differ in terms of maturity periods, interest payments, and investment purposes. Government securities are considered safe investments as they are backed by the government, which guarantees the return of interest and principal.

Maturity Periods

Treasury bills, or T-bills, are short-term securities with maturity periods of one year or less, typically ranging from 91 days to 365 days. On the other hand, government bonds, also known as dated securities, are long-term securities with maturity periods of one year or more, up to 40 years.

Interest Payments

T-bills are zero-coupon securities, which means they are issued at a discount and redeemed at face value upon maturity. The difference between the discounted purchase price and the face value received at maturity represents the investor's gain. Government bonds, on the other hand, pay interest periodically, usually every six months, and the principal is returned upon maturity.

Investment Purposes

T-bills are suitable for investors who need short-term cash management or want to hold a near-cash position in their portfolio. They are also attractive to investors who need to preserve their capital. Government bonds, with their longer maturity periods, are more appropriate for long-term investing, income generation, or hedging against stock market volatility. They offer higher interest rates compared to T-bills and are often used by investors seeking a steady income during retirement or for major expenses such as education.

Risks and Returns

Both government bonds and T-bills are considered low-risk investments due to the guarantee of the government. However, the longer maturity of government bonds makes them more sensitive to interest rate changes, resulting in larger price swings compared to T-bills. As a result, government bonds typically offer higher returns than T-bills, but they also carry a higher risk of loss if sold before maturity.

Primary auctions vs. secondary markets

The primary market is where securities are created and first issued, while the secondary market is where they are traded among investors. In the primary market, companies sell new stocks and bonds to the public for the first time, such as with an initial public offering (IPO). The secondary market is essentially the stock market, including the New York Stock Exchange (NYSE), Nasdaq, and other major exchanges worldwide.

In the context of investing in government securities in India, the primary market is where investors can buy government bonds directly from the market through various methods. One way is by investing via GILT mutual funds, which are considered one of the most common ways of investing in government bonds. Another way is by creating a trading Demat account with a bank, which can be done at any bank or NBFC in India. Once the account is created, investors can use their login credentials to initiate trading and investing in multiple government securities. A third way is by participating in bidding, where investors can buy government bonds from a stockbroker by partaking in non-competitive bidding (NCB).

On the other hand, the secondary market is where investors trade previously issued securities without the involvement of the issuing companies. For example, if an investor wants to buy shares of a company, they would be dealing with another investor who owns shares in that company. The issuing company is not directly involved in the transaction.

The primary market provides companies and governments with access to funding necessary for growth and development, while the secondary market enhances market efficiency by providing liquidity and price discovery. It allows investors to trade securities more freely without being concerned about economic development.

Fixed-rate vs. floating-rate bonds

Fixed-rate bonds are a type of debt instrument that yields the same level of interest throughout its entire term. They are also known as fixed-income securities. The fixed-rate is mentioned in the trust indenture during issuance and must be paid on pre-fixed dates until the bond matures. Fixed-rate bonds are typically contrasted with floating- or variable-rate bonds.

Floating-rate bonds are debt instruments that do not have a fixed coupon rate. Instead, their interest rate fluctuates based on several predetermined benchmarks. These benchmarks are market instruments that influence the overall economy, such as repo rates or reverse repo rates.

Advantages and disadvantages of fixed-rate bonds

One of the main benefits of fixed-rate bonds is that investors know the exact amount of interest they will earn and for how long. This makes it easier to develop a financial plan and achieve investment goals. However, a disadvantage is that investors who withdraw their bonds prematurely are usually subject to penalties. Additionally, fixed-rate bonds are susceptible to interest rate risk, which means that investors may lose out on generating attractive returns if inflation rates increase.

Advantages and disadvantages of floating-rate bonds

Floating-rate bonds offer the advantage of flexibility, as they can reflect the current interest rate of the market. If the interest rate of the benchmark rises, the interest rate payable on the floating-rate bond also increases. Floating-rate bonds also tend to have less exposure to volatility or negative price movement. On the other hand, a disadvantage is that they may end up paying a lower yield than fixed-rate bonds if the short-term benchmark rate falls. Floating-rate bonds also carry interest rate risk, as there is no guarantee that the interest rate will rise at the same pace as market interest rates.

How to invest in government securities in India

Government securities in India, also known as G-Secs, are issued by the Central Government to borrow funds from the financial market and meet its fiscal deficit. These securities can be short-term (maturity of less than 1 year) or long-term (maturity of 1 year or more). Short-term securities are called Treasury Bills (T-Bills) and long-term securities are called Government Bonds or Dated Securities. Investors can buy government bonds directly from the market or through GILT mutual funds. Another option is to create a trading Demat account with a bank, which can be done at any bank or NBFC in India.

Sovereign gold bonds

SGBs were launched by the Indian government in November 2015 under the Gold Monetisation Scheme. The Reserve Bank of India (RBI) issues these bonds for subscription in tranches, in consultation with the Government of India. The RBI notifies the terms and conditions for the scheme periodically. The subscription calendar for SGBs is made public, and the rate is declared before each new tranche.

The minimum investment in SGBs is 1 gram of gold, with a basic unit of 1 gram. The maximum limit for individuals is 4 kg, 4 kg for Hindu Undivided Families (HUF), and 20 kg for trusts and similar entities per fiscal year. The tenor of the bond is eight years, with an early exit option in the fifth, sixth, and seventh years.

The bonds are denominated in multiples of gram(s) of gold and can be purchased through ICICI Bank internet banking or the iMobile application. They are restricted for sale to resident Indian entities, including individuals, HUFs, trusts, universities, and charitable institutions. Know-your-customer (KYC) norms are the same as those for purchasing physical gold, and documents such as Voter ID, Aadhaar card, PAN card, TAN card, or Passport are required.

The redemption price for SGBs is based on the simple average of the closing price of gold of 999 purity over the previous three working days, as published by the Indian Bullion and Jewellers Association (IBJA). The interest on these bonds is taxable per the Income Tax Act, 1961, but the capital gains tax arising from redemption is exempted.

Inflation-indexed bonds

Assuming an initial investment of Rs 1000, an inflation rate of 3% in the first year, and an inflation rate of 6% in the second year, with a promised interest rate of 3%:

• At the end of the first year, the principal amount will be Rs 1030 (initial investment + inflation accrual), and the interest earned will be Rs 31 (1030 x 3/100).
• At the end of the second year, the principal amount will be Rs 1091.80 (1030 + inflation accrual for the second year), and the interest earned will be Rs 32.70 (1091.80 x 3/100).

Thus, the total return at the end of the second year is Rs 94.50 (inflation accrual of Rs 61.80 + interest of Rs 32.70).

It is important to note that the inflation component is adjusted in the principal amount, and at the time of redemption, the investor will receive the adjusted principal or the face value, whichever is higher. In the case of deflation, the interest payments decrease, but the capital does not decline below the initial investment.

IIBs are treated as government securities (G-Sec) in India and are eligible for short-sale and repo transactions. They are also eligible to be included in the Statutory Liquidity Ratio (SLR) requirements of banks. The issuance of IIBs gained significance in India between 2008 and 2013, when the economy experienced high inflation and negative real interest rates. The Indian government launched IIBs on June 4, 2013, to reduce the attractiveness of gold as an investment option and to lower the current account deficit. These bonds were issued monthly until December 2013, offering an annual return of 1.44% over the headline inflation rate.

Frequently asked questions