RBI has announced the launch of the Government of India Floating Rate Savings Bonds. The bonds shall be available for subscription from July 1, 2020. In this post, let us discuss the new floating rate bonds in detail and answer the following questions.
- What are the important features?
- How is it different from the RBI 7.75% Savings Bonds?
- How does it compare against similar low risk investment products such as PMVVY, SCSS and Bank Fixed Deposit?
- Should you invest in these bonds?
Govt. of India Floating Rate Bonds 2020 (Taxable): Important Features
- Interest Rate is floating.
- You don’t get a fixed interest for the duration of the bonds. You DO NOT lock-in the rate of interest until maturity.
- Interest Rate Benchmark: The interest rate is benchmarked to the National Savings Scheme (NSC interest rate). The rate shall be 0.35% higher than the NSC rate.
- Interest Reset Dates: The interest rate will be reset every six months on January 1 and July 1. This is much like your home loan interest rate where the interest rate is revised regularly. You can think of it as a bank fixed deposit where interest rate changes every six months.
- Interest Payment Dates: Interest pay-out every six months on January 1 and July 1. The bonds are NOT available in cumulative mode. Only non-cumulative mode (regular interest pay-out option available.
- For the first six months (from July 1 until December 31, 2020), you will get 7.15%. p.a. (NSC rate 6.80% + Spread of 35 bps)
- Maturity: The bonds mature in 7 years.
- Minimum Investment: Rs 1,000
- Maximum Investment: There is no maximum limit on investment in RBI Floating Rate bonds.
- Who can invest? Individuals (including in the joint name) and the Hindu Undivided Family can invest.
- Can NRIs invest? Non-resident individuals (NRIs) CAN NOT invest in these bonds. However, if you become NRI after the purchase of bonds, you can hold the bonds until maturity.
- Tax Benefit on Investment: No tax benefit for investment in these bonds
- Tax Treatment of Interest: Interest is taxable at your marginal (income tax slab) rate.
- Transfer of Bonds: These RBI Floating Rate Bonds are NOT tradeable in the secondary market. In the event of the demise of the bondholder, the bonds shall be transferred in the name of the nominee or the legal heir.
- Loan against these Bonds: You CAN NOT take a loan against these bonds.
- How to invest? You can submit the application at the branches of leading public and private sector banks. Soon, you will be able to invest online through broker websites and Stock Holding Corporation (SHCIL) website.
- Holding Mode: The bonds shall be held in the digital mode in Bond Ledger Account (BLA). You do not need a demat account to invest in these bonds. A simple paper application will do. A BLA holding certificate will be issued as proof of subscription.
- Premature Exit: Possible only for senior citizens. Even for senior citizens, there is a minimum lock-in. Age between 60 and 70: Minimum 6 years; Between 70 and 80 years: Minimum 5 years; 80 years and above: Minimum 4 years. A penalty of 50% of the interest payable over the last six months on premature exit.
- Tax Deduction at Source: TDS applicable on all interest payments. As I understand, self-declaration forms such as Form 15G/15H will not work. You need a certificate from the Income Tax department if you want to avoid TDS.
- No credit risk. You are lending money to the Government of India. It will be repaid on time.
RBI Floating Rate Savings Bonds (2020) vs RBI 7.75% taxable Savings Bonds (2018)
This comparison is meaningless since RBI 7.75% Savings Bonds were withdrawn in May, 2020.
There are just a couple of differences.
With RBI 7.75% Savings Bond, the interest rate was fixed. All those who managed to invest in these bonds will earn 7.75% p.a. until maturity.
With RBI Floating Rate bonds, the interest rate is NOT fixed. It is a floating rate bond. The interest rate will be reset every six months. And it is linked to the interest rate of National Savings Certificate (NSC). 0.35% over the NSC interest rate. From July 1 until December 31, 2020, you will earn 7.15% p.a. (NSC rate 6.8% p.a. + 0.35%). Therefore, the interest rate you earn can change. Do note the NSC rate is revised every quarter. However, the RBI Floating rate bonds interest will be reset on July 1 and January 1 every year,
RBI 7.75% Savings Bonds provided Cumulative interest option too i.e. you could choose to take the entire interest at the time of maturity.
The new RBI floating rate bonds do not provide cumulative interest pay-out option. The interest shall be paid on a six-monthly basis.
RBI Floating Rate Savings Bonds: Comparison with PMVVY, SCSS and Bank Fixed Deposits
Pradhan Mantri Vaya Vandana Yojana (PMVVY):
Only for senior citizens. Maturity: 10 years. Maximum Investment: Rs 15 lacs per person. Current Rate of Interest: 7.4% p.a. Interest Payment: Monthly/Quarterly/Half-yearly/Annual. Interest Rate: Revised every year. No credit risk.
For more on PMVVY, refer to this post.
Senior Citizens Savings Scheme (SCSS):
Only for senior citizens. Maturity: 5 years. Maximum Investment: Rs 15 lacs per person. Current Rate of Interest: 7.4% p.a. Interest Payment: Quarterly. Interest Rate: Revised every year. No credit risk
Bank Fixed Deposits
No age bar. Anybody can invest. Maturity: Multiple. Maximum investment: No limit. Rate of Interest: Varies across banks and maturity. Interest Payment: Monthly/Quarterly/Half-yearly/Annual. Low Credit risk
RBI Floating Rate Bonds
No age bar. Anybody can invest. Maturity: 7 years. Maximum investment: No limit. Rate of Interest: Floating (NSC Interest Rate + 0.35%). Interest Rate Reset: Six-monthly (January 1 and July 1). Interest payment: Six-monthly (January 1 and July 1). No credit risk.
With PMVVY and SCSS too, the interest keeps changing. For instance, with SCSS, the rate of interest is revised every quarter. With PMVVY, the rate of interest will be revised annually. At present, the interest rate for both PMVVY and SCSS is 7.4% p.a.
However, there is one big difference. Once you invest in PMVVY and SCSS, the rate of interest is locked in. You will get the same rate of interest until maturity. Even if the interest rate is revised, the new interest rate is applicable only to the new investments/deposits. There is no impact on the old investments. You get the contracted rate of interest until maturity. Much like a bank fixed deposit.
With RBI Floating Rate Savings Bonds, there is no such comfort. Whenever the interest rate is revised, it will be applicable to both new and the old investors. For instance, if you invest Rs 1 lacs today, you will get 7.15% p.a. (the prevailing rate) for the first six month. After 6 months, if the interest rate is revised to 6.75% p.a., you will get a lower rate for the next months.
Should you invest in RBI Floating Rate Savings Bonds?
Let us first quickly write down the pros.
No credit risk. A good rate of interest for zero-risk-product.
Now, to the cons.
Interest is taxable. Brings down effective returns for those in the higher income tax bracket. No liquidity. You cannot lock-in the rate of interest for 7 years. You can lock-in interest with other competing products such as PMVVY, SCSS, and bank fixed deposits. When it comes to locking in the interest rate for life, there is no better product than an annuity plan but you must purchase the right variant at the right age.
If you are still working, have no need for income and fall in the 30% tax-bracket, the utility of an income product automatically goes down.
Foe everybody else, the answer is more nuanced.
If you are still working and fall in low income tax brackets, it depends on whether you need income. If you need income, there may be merit in such a product. If you do not need income, you will have to reinvest the interest income. What are your plans?
If you are a senior citizen or a retiree, this product can be quite useful. Not as simple as bank fixed deposit but still easy to understand. The only problem is the floating interest rate. At the same time, we must understand that the rate is linked to NSC, where the interest rate is generally high.
By the way, a floating interest rate is not always a problem.
We are in an economic environment that I think interest rates are more likely to fall than rise. Growth is subdued. Inflation is low. This can make you uncomfortable with a floating rate bond. You might want to lock-in a higher rate of interest for a longer duration, if possible.
However, the interest rates tend to move in cycles. It is possible that the interest outlook might change after a few years. During such times, these floating rate bonds will look extremely attractive.
In the current context, consider other options too. If you need income, try to lock-in a higher rate of interest with other products. If that’s not an option (bank is offering lower interest or you have exhausted PMVVY/SCSS) limit, you can invest in these bonds.
In my opinion, a floating rate savings bond is a product that is fair to both the investor and the borrower (Government of India).