Domestic Bonds

Explained: what to consider before investing directly in government securities

Earlier this week, the Reserve Bank of India unveiled a program allowing retail investors to participate directly in the government securities market. They can open and maintain a “Gold Direct Retail Account” (RDG Account) with the RBI through a portal, which will also provide access to G-Sec’s primary issue and secondary market. In February, the RBI offered private individuals access to this risk-free bond segment.

Greater participation will support the government’s expanding borrowing plan, estimated at around Rs 12 lakh crore per year. It can also compete with bank term deposits and postal savings.

What are G-Sec?

These are debt securities issued by the government. They are considered the safest form of investment; the government will not default because it has the opportunity to raise funds through taxes and other means if it is faced with repayment problems. Retail investors were allowed to buy and sell treasury bills, government bonds, sovereign gold bonds as well as government development loans.

Currently, retail investors are allowed to submit non-competitive bids in government bond auctions. They could access Negotiated Dealing System-Order Matching (NDS-OM) through exchanges, which would aggregate the demand for gilts and place it at the RBI in NDS-OM.

Now a retail investor can open a gilt account with the RBI and place a direct bid on NDS-OM as well as trade in the secondary market. Until now, only institutional players such as banks, primary dealers, insurance companies, mutual funds, foreign portfolio investors and high net worth individuals had direct access to this platform. Gilts are normally traded on NDS-OM in lots of Rs 5 crore each, but retail investors have been allowed to trade with a minimum investment of Rs 10,000.

How will the RBI program work?

To register online, investors must have a rupee savings account in India, PAN and a valid document for KYC. Non-resident retail investors are permitted to invest in government securities under the Foreign Exchange Management Act 1999. An RDG account can be opened individually or jointly.

Investors complete an online form. Once their RDG account is opened, the details to access the portal will be sent by SMS / email. No fees will be charged for opening / maintaining the account or placing offers.

For participation in the primary market, only one offer per security is authorized. Payment can be made via net-banking / UPI. If UPI is used, funds from the linked bank account may be blocked at the time of bid submission; the amount will be debited at the time of allocation during the auction. A similar facility through banks will be made available in due course.

Allocated securities will be issued by credit to the investor’s RDG account on the day of settlement. Refunds, if any, will be credited to the investor’s bank account.

For secondary market transactions, registered investors can access a transaction link on the portal to buy or sell gilts. The securities purchased will be credited to the RDG account on the day of settlement. The RBI will announce the start date of the program.

How can investors benefit from it?

G-Secs add to the variety of debt investing options. Besides interest income, investors can also realize capital gains by trading gilts, depending on the trajectory of interest rates. If an individual holds a bond with a yield of 6%, a rise in bond yields will lower the price of the bond. Thus, if he wishes to trade the bond before maturity, the increase in yield results in a loss of capital. On the other hand, a drop in yield below 6% would benefit the investor as the price of the bond would rise.

Investors also face a low risk of reinvestment if they are saving for retirement. While term deposits are available for up to 10 years and thus expose the investor to reinvestment risk, a G-Sec investor can lock in to the current yield for 20 to 30 years.

What are the risks of investing directly?

Since G-Secs are highly volatile, investment experts say investors who truly understand these instruments or are willing to hold them to maturity should consider them. Many argue that while this is a safe asset class, it is best to invest in mutual funds that invest in G-Secs. For investors who are willing to hold to maturity and aren’t bothered by volatility, one of the benefits of going straight is that they’ll save on the expense ratio charged by mutual funds.

G-Sec is taxed on both interest income and capital gains if the papers are traded in the market before maturity. Interest income is taxable at the marginal tax rate and capital gains at 10%. G-Secs do not attract capital gains tax if the papers are held to maturity.

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What should be kept in mind when investing directly in G-Secs?

G-Sec yields move due to a variety of factors, and investors will need to keep an eye on domestic and global developments. In the market, people say that fixed income investors are sinking and sailing in the direction of interest rates. Investors suffer capital losses in a rising interest rate regime and realize capital gains in a falling rate environment. This risk is eliminated when the gilts are held to maturity.

Inflation and interest rates, in turn, are affected by various other factors such as economic growth, sovereign rating, money supply, government borrowing, global liquidity, and geopolitical developments. Investors must therefore be attentive to all of this.