Government Bonds

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 in India issued by the state governments of India are known as State Development Loans (SDLs). Government bonds are usually issued with tenures of 5 to 40 years.

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 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:

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 "all 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 Jewellers 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.

Government bond yield in India refers to the return that an investor earns or expects to earn from his/her investment in government bonds. Interest payments and the capital gains/losses (if there are any) earned on the sale of a bond or at maturity are considered when calculating government bond yields.

Government bond yields are often used as a benchmark for setting interest rates for corporate bonds, loans, fixed deposits and other fixed income instruments of the same maturity profile. In India, the 10-year government bond yield serves as a benchmark or reference rate for the entire bond market and often serves as a key indicator of inflation rate and interest rate expectations.

When investors buy government bonds online, they become lenders to the government. In return, they receive regular half-yearly interest payments, and at maturity, the government repays the bond's full face value.

Below are a few key terms related to government bonds that every investor should know about:

Investing in government bonds in India offers several clear advantages:

Government bonds are considered risk-free investments as their chances of defaulting are negligible. However, as with other bond types, government bonds also carry other risks. A few of these risks are mentioned below:

For detailed comparison, check Government Bonds vs Corporate Bonds

Like other market-linked instruments, the prices of government bonds too fluctuate in the secondary market. The following factors may affect the prices of government bonds in India:

The taxation on government bonds in India involves two components - interest income and capital gains.

Taxation on the Interest Income of Government Bonds

The interest income earned from a government bond in India is added to the bondholder's total income and is taxed as per his/her tax slab. To prevent TDS (tax deducted at source) on the interest income of a government bond, the bondholder can submit 15G/15H forms, which basically confirm that there is no tax liability.

Taxation on the Capital Gains of Government Bonds

The taxation on capital gains in India depends on how long you have held the government bonds. Short-Term Capital Gains (STCG) (gains on assets held for a period of up to 12 months) are taxed according to the tax slab rate of an investor; and the long-term capital gains (LTCG) (gains on assets held for a period more than 12 months) are taxed at 12.5% (in case of listed bonds and if the indexation benefit has not been availed) and 20% (in case of unlisted bonds).

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