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Investing in government securities is set to become easier. In the Reserve Bank of India’s (RBI) monetary policy announcement made earlier today, the RBI Governor Shaktikanta Das said that retail investors will be given online access to the government securities market – both primary and secondary- along with the facility to open their gilt securities accounts –with the RBI. This facility will be called Retail Direct. The details of the facility will be announced later. This is not the first time that the RBI has encouraged retail investors to invest in g-secs. So far, there has been a lukewarm response. But experts predict that the latest move ought to bring in more retail investors in the g-secs market. Here’s what you should know about RBI’s latest move and how it can benefit you.What are government securities (g-secs)?
These are debt instruments issued by the Reserve Bank of India, on behalf of the Central Government. The state governments also raise money by issuing such instruments; those are called State-Development loans.
G-secs come in varying tenures; from 6 months to up to 40 years. Interest is generally paid twice a year and taxable at your income-tax slab rates. The 10-year government security bond yield is a widely tracked number by market participants to assess the long term interest rate movement in the economy. It is typically referred to as a benchmark security. The 10-year g-sec current yield is 6.11 per cent.
You will now be able to buy any of these bonds, directly from the primary and secondary market. G-secs are backed by the central government and do not carry any credit risk.Does that mean they are entirely zero-risk?
No. Although government securities do not carry credit risk, they are not a risk-free instrument. They are subject to interest rate risk. If the interest rates go up, the bond prices fall.
And here’s where, you as an investor should be careful, given the times we are in at present. Budget 2021 has announced a massive borrowing program, which is bound to push up bond yields, sooner or later. When this happens, prices of debt securities- including g-secs- will fall.
In the last three years ended February 4, 2021 gilt mutual funds (schemes that invest in g-secs) gave 9.49 percent returns on the back of falling interest rates. This will not continue for long once interest rates begin to go up again.G-secs are old instruments. But why have retail investors avoided them secs so far?
Since g-secs carry low risks, the commensurate returns offered are also low. Interest rates have not been attractive when compared to other fixed-income instruments like company fixed deposits, small saving instruments and non-convertible debentures. For example, Power Finance Corporation, a CPSE issued a 10 year NCD at 7 percent coupon which was higher than the 10 year G-sec yield quoting tad below 6 percent. “Retail investors looking for high yield on their fixed income investments typically find investments in government bonds unattractive,” says Vikram Dalal, founder and Managing Director of Synergee Capital Services.
Poor liquidity in the secondary market is a cause of concern for most investors. Though NSE-GoBID facility or platform allows investors to buy gilts in the auctions and receive it into their demat accounts, baring rare cases, there are no volumes on the exchanges. The only way out for the investors to sell these bonds is to transfer them to a constituent subsidiary general ledger (CSGL) account and then sell it.
Most investors do not understand how CSGL account works. The CGSL is a sort of a demat account that holds government securities and facilitates trade on Negotiated Dealing System- order matching system (NDS-OM). “Conversion to CSGL format from demat format takes around 10 days,” says Dalal.
Another big problem is the lot size required to trade in g-secs. Typically, g-sec market sees trades worth Rs 5 crore and above. There’s little liquidity if you wish to buy and sell g-secs worth an amount less than Rs 5 crore. Such trades, if they happen, do not take place at fair price. In most cases, you are forced to hold the bond till maturity.
A few banks attempted to offer investors opportunities to invest in government securities. However, it did not generate volumes. NSE-Go Bid platform allowed the investors to participate in the auction of government securities on non-competitive basis. In June 2019, RBI also allowed non-competitive bidding in state development loans.
Hence, mutual funds have so far remained the best way for retail investors to invest in g-secs.Will Retail Direct for g-secs be smooth?
While detailed guidelines are awaited, the RBI has opened up an instrument that has traditionally been the bastion of large institutional investors only. “It may just be the beginning of a viable substitute for small savings schemes at market rates. However, much like sovereign gold bonds, the likely pick-up pace will be at a slow rate,” says Mahendra Jajoo, Chief Investment Officer- Fixed Income, Mirae Asset Management India.
Existing NSE-GoBID facility allows individual investors to buy government securities by participating through non-competitive bidding wherein the investors are issued bonds at cut-off price arrived at by the other institutional participants in auction. “Investor on NSE-GoBID cannot specify the price at which he want to buy. He is a price taker. The new (direct) system should allow individual investors to quote the yield at which they want to buy the government bonds,” says Deepak Panjwani, Head- Debt Markets, GEPL Capital.
Modality of the operational guidelines about the ‘account’ in which the individual investor will hold the securities will also be watched. The difference between demat and CSGL is already a dampener. In the new system, since the investor is opening an ‘account with RBI’, the arrangement should allow him to trade in government securities on NDS-OM.
“To ensure liquidity in secondary trades, the RBI may consider appointment of market makers to offer two way quotes. RBI may choose to offer market making facility through some institution such as primary dealers to only retail investors or to the trades of certain size –say from Rs 10, 000 to Rs 10 lakh,” says Joydeep Sen, corporate trainer (Debt market).
“RBI can also encourage retail participation by allowing retail investors to sell government bonds held by them to RBI in the open market operations conducted by RBI,” says Panjwani.
Should you go for it?
Details are awaited on how easy or tough it would be to buy these g-secs, directly.
But make sure you understand how interest rate risks work. It’s fine to invest in a 20-year or 40-year government paper and hold them till maturity. In theory it looks good, but the interim volatility can unnerving. Rising interest rates lead to a fall in bond prices and cause you a capital loss if you sell it at that point.
Lastly, watch out for the yields; they’ll be among the lowest since g-secs do not carry credit risk.