In February, the Reserve Bank of India announced that it would allow retail investors to directly purchase government bonds, considered the safest kind of investment. With this move, India would become the first country in Asia to allow direct retail participation in government securities (GILTs or G-Secs).
What does this mean for a retail investor—and what are the risks involved in the process? You can find all your questions about investing in GILTs answered below.
What are GILTS (G-Secs)
GILTS (G-Secs) are Government Bonds which have a very low risk of default and consequently low returns. They are called GILTS because the original certificates issued by the British Government had gilded edges.
Every year, the government budget will show different kinds of receipts: Corporation tax, Income Tax, GST, Custom Duty and other income sources. At the same time, the government incurs different types of expenditure under different heads like revenue and capital (for paying salaries, building roads/infrastructure, and capitalizing public sector units). The gap between the expenditure and income is the surplus or deficit.
Most governments in the world have a deficit budget and finance it either by borrowing or printing of notes. In India, our government generally resorts to match the deficit by borrowing from various quarters and paying interest on the borrowing. For government borrowing, the RBI issues tradeable Bonds (long term, beyond one year) and treasury bills (also called t-bills for short term borrowings up to one year). The subscription to these are made by banks, mutual funds, large financial institutions, primary dealers, provident funds, FPIs (to a limited extent) and insurance companies (by competitive bidding).
When an investor buys government bonds that investor is a creditor loaning money to the government.
What are the returns from government bonds?
An investor who purchases a bond can expect returns from either:
The coupon/interest payments made by the issuer.
Any capital gain (or loss) when the bond is sold or it matures
Income from reinvestment of the interest payment (Half Yearly) which is interest compounded.
Coupon Yield: This is the coupon payment as a percentage of the face value and refers to the nominal interest payable.
Current Yield: This is the coupon payment as a percentage of the bond’s purchase price; in other words it is the return a holder of the bond gets against its purchase price, which may be more or less than the face value or the par value of the bond.
Yield to Maturity: This is the internal rate of return of the Bond.
What are the risks involved in holding G-Secs?
There are four types of risk involved in the holding and trading of G-Secs:
Market Risk: Market risk arises out of adverse movement of price of the securities due to change in interest rates. The Retail investors need to understand this risk as most would be unaware that the price of the asset changes with the rise and fall in interest rates and is different from a fixed deposit market.
Reinvestment Risk: The cash flows generated out of the half yearly coupon payment have to be reinvested at yield prevalent at the time of their payment.
Liquidity Risk: Liquidity risk is the risk arising out of inability of the buyer to sell the holdings due to non-availability of buyers.
Sovereign Risk: This risk arises due to inability of the Government to repay the bonds back to the investor which is generally Zero in case of Government of India as the repayment of these securities are guaranteed by the RBI and there is very low risk of default.
Are retail investors allowed to invest in G-Secs?
There have been several initiatives in the past to allow retail investor participation in the G-Secs market. Examples include non-competitive bidding in primary auctions, permitting stock exchanges to act as aggregators/facilitators for retail investors and allowing odd-lot segment in the secondary market.
In the current year, due to COVID-19, government borrowing has increased considerably. Even in the next financial year, the government will be borrowing about Rs 12 lakh crore. Now RBI has decided to increase retail participation in G-Secs so that the corporates are able to access the borrowing market without any disruption due to the high government borrowing. The RBI has decided to move beyond the aggregator model and provide retail investors online access to the government securities market—both primary and secondary—along with the facility to open their Gilts Securities Account with RBI. Details of the facility will be released at a later date.
What are the advantages of this move by the RBI?
It is a big structural reform, a revolutionary step of the GOI and India will be the first country in Asia to give access of G-Secs to Retail Investors. Very few countries in the world allow this facility to Retail Investors.
It will deepen/broad base the Bond Market as more funds will be available with the corporates who can raise financing from Markets without Govt. borrowing disruption.
The attractiveness of the bond will be a higher yield than that from fixed deposits and will result in dis-intermediation of the fixed deposit markets.
It will give investors a moderate and safe returns.
When interest rates move higher an investor can invest in the market as the prices of the Gilts then will be lower and then wait for the prices to move higher when he can sell it.
Tax implications
Tax at normal rates will be applied on the interest earned on the securities while tax on gains in the prices will be as per the long term capital gains/short term capital gains.
We await the RBI Circular to know the complete details of the scheme.
The author is Head Of Treasury at Finrex Treasury Advisors
