What are Government Bonds (Dated Securities)?
Government Bonds, also known as Dated Securities, are long-term debt instruments with an original maturity of one year or more. The central and state governments use government bonds to raise funds to support their spending and obligations. Bonds issued by the state governments are known as State Development Loans (SDLs). Government bonds are usually issued with tenures of 5 to 40 years.
Types of Government Bonds
Fixed Rate Bond has a fixed coupon rate (interest rate), i.e., it remains the same till its maturity. Most government bonds in India are issued as fixed rate bonds.
Floating Rate Bond (FRB) does not have a fixed coupon rate. Instead, their coupon rates are resets at pre-announced intervals, for instance, half-yearly or annually. There are two main ways in which the coupon rate is decided:
- The coupon rate can be the average rate (rounded off up to two decimal places) of the implicit yields at the cut-off prices of the last three auctions held before the rate setting date.
- The FRB can also carry a coupon rate, which has a base rate and a spread. The spread is decided at the time of bond issuance and remains the same for the entire duration of the bond. The base rate, on the other hand, is equivalent to the Weighted Average Yield of the last three auctions from the rate fixing day.
Zero Coupon Bonds do not offer any coupon payments. Instead, they are issued at a discount and redeemed at face value. The Government of India last issued these bonds in 1996.
Capital Indexed Bonds have their principal amount linked to a pre-determined inflation index with the aim to protect the investor’s principal amount from the impact of inflation.
Inflation Indexed Bond (IIB) were also introduced to protect the government bondholders from inflation. However, in case of IIBs, both the interest flows and the principal amount is linked to a pre-set inflation index. The index used for this purpose can be either the Wholesale Price Index (WPI) or the Consumer Price Index (CPI).
Bonds with Call/Put Options provide flexibility for early redemption either by the issuer or investor. Bonds with ‘call option’ gives the issuer (i.e., the Government) the right to buy back the bond before their maturity dates. On the other hand, bonds with a ‘put option’ gives their investors the right to sell their bonds back to the issuer before their maturity dates.
Governments can issue bonds having either of the pull or call option. Some government bonds may have both put and call options.
Special Securities are long-term bonds that the Government of India issues from time-to-time to entities such as Oil Marketing Companies (as oil bonds), Fertilizer Companies (as fertiliser bonds) and the Food Corporation of India (as food bonds). The government issues special securities to these entities as a means of compensating them in lieu of cash subsidies.
These securities usually offer a higher coupon rate than the yield of the government bonds of similar maturities. The entities that receive these securities can sell them in the secondary market to banks, insurance companies or primary dealers, etc. for raising funds.
Sovereign Gold Bond (SGB) has its value directly linked to the price of gold, thereby, allowing investors to invest in gold without buying physical gold. These bonds are denominated in grams of gold, with a minimum investment of 1 gram. The maximum purchase limit for a financial year is 4 kg for individuals and Hindu Undivided Families (HUFs) and 20 kg for trusts and similar entities.
SGBs have a maturity period of 8 years but investors can opt for premature redemption after 5 years, which is allowed only on the next interest payment date. SGBs offer a fixed interest rate of 2.5% p.a. on the nominal value, paid semi-annually, with the final interest paid along with the principal at maturity. The redemption price is also based on the average closing price of 999 purity gold over the last three business days before the maturity date, as published by India Bullion and Jewelers Association Limited (IBJA).
7.75% Savings (Taxable) Bonds, 2018 can be held by Resident Indians and Hindu Undivided Families (HUFs). Resident Indians can invest in these bonds individually or with another individual, on a ‘either or survivor’ basis, or on behalf of a minor as a parent or legal guardian.
There is no maximum investment limit for these bonds. They are issued at par for a minimum investment of Rs 1,000 (face value) and in multiples thereof. The interest rate is 7.75% p.a. and the interest earned is taxable according to the investor’s applicable tax status. However, these bonds are exempt from wealth tax.
State Development Loans (SDLs) are government bonds issued by the State Governments. The coupon payments for SDL are made every six months and the principal amount is repaid at maturity.
In terms of safety of capital, SDLs are similar to G-Secs. SDLs have quasi-sovereign status as the RBI directly monitors interest and maturity payments of these bonds and also has the power to make the pay-outs for these bonds from the budgetary allocation of the Central government for the bond issuing state government.
Why Should You Invest in Government Bonds?
Investing in government bonds offers several clear advantages:
Safety and Sovereign Guarantee: Government bonds offer maximum possible safety of capital and certainty of returns to the investors as the repayment of principal and interest components are guaranteed by the Government of India.
Ease of Holding: Government bonds can be held in dematerialized (electronic) or physical form, reducing risks related to loss, theft or damage.
Wider Variety of Maturities: The tenure of government bonds can range from 5 years to 40 years. This provides investors a wider choice to lock in attractive yields as per their investment horizon. Investors having shorter investment horizons can also purchase government bonds having shorter maturities from the secondary market.
Liquidity: Government bonds can be traded in the secondary market. Investors can exit the market without incurring any prepayment penalty. However, the sale proceeds will depend on the prevalent market price of the bond.
Attractive Yields: State Development Loans (SDLs) often offer higher yields to attract investors.
Minimal Market Risk If Held Till Maturity Date: Government bonds are subject to price fluctuations due to changes in the interest rates, inflation rates, liquidity in the market, fiscal deficit, foreign exchange movements and other macro-economic factors. However, if held until maturity date, these risks can be eliminated. Upon maturity, investors receive the full-face value, regardless of interim market movements.
How to Invest in Government Bonds in India?
Retail investors can invest in government bonds through auctions conducted by the RBI. The minimum investment amount required to invest in government bonds is Rs 10,000. The RBI allocates a separate quota for retail investors in each bond auction to encourage retail investment.
Investors can invest directly in G-Sec by opening gilt accounts with banks and RBI. They can use their existing demat accounts for holding government bonds.
Other options that retail investors can use for investing in government bonds include RBI Retail Direct, NSE goBID (Government Bond Investment Destination), BSE Direct, stock brokers and bond-purchasing platforms.