You can now invest online in Government Bonds easily. Should you?

Investing in Government Securities has become simpler. The Reserve Bank of India had notified, in November 2017, that stock exchanges can act as aggregators for retail investor and thus facilitate bidding for Government securities at RBI auctions.

Discount broker Zerodha and NSE came out with the online facility to purchase Government bonds recently (late 2018).

In this post, let’s look at how you can invest in Government Securities and what are the pros and cons.

Here is what you need to know:

1. The Reserve Banks auctions Government Securities (T-Bills or G-Sec bonds) on a regular basis. Now, you can participate in such auctions through non-competitive bidding (discussed later) and get Government securities in your demat account.
2. You can find information about active or upcoming auctions through RBI press releases or NSE website. Your broker will also show active issues on its website.
3. You will get interest and the maturity proceeds directly in your bank account.
4. Minimum investment of Rs 10,000 per security per auction.
5. Maximum investment: Rs 2 crores (in multiples of Rs 10,000) per security per auction. There is no limit to the quantum of Government Securities you can hold.
6. 5% of the sale (auction) amount per auction is reserved for non-competitive bidding.
7. RBI caps the brokerage/commission/services for facilitating the purchase of Government Securities at 6 paise per Rs 100 (0.06%). As I understand, this cap is only for non-competitive bidding. The brokerage for transacting in the secondary market can be very different.

Treasury Bills and Government Bonds

Treasury Bills (or T-Bills) are issued by the Government of India in tenures of 91 days, 182 days and 364 days. Treasury bills are zero-coupon securities (do not pay interest) and are issued at discount to face value. The discount on the face value constitutes the return for the lender/investor. For instance, a 182 day T-bill with face value of Rs 100 will be issued at discount to you at say Rs 97. At maturity (after 182 days), the bill will mature at Rs 100.

A G-sec bond (Dated G-Secs) are long duration Government bonds and the maturity ranges from 5 years to 40 years. The interest is paid on the bonds twice a year on a semi-annual basis. At the time of maturity, you get back the Face Value (which can be different from your purchase price).

What is Non-Competitive Bidding?

Government bonds or Treasury Bills are sold through auctions. Bidding for the fresh issuances is done in terms of the rate of interest (coupon). Bidding for re-issuance of existing securities is done on price. By the way, none of this should concern you.  From the perspective of the Government (borrower in this case), the lower rate of interest (for fresh securities) and higher price (for re-issuances) is better.

Retail investors purchase these securities by way of non-competitive bidding. Essentially, you do not really have to make a bid. When you express your interest to purchase through your broker, you get the securities at the weighted average price during the auction.

For instance, let’s assume the cut-off interest rate for a fresh issuance is 8.5% p.a. The cut-off is decided based on the bidding by the bigger players like banks. However, the average cut-off rate is 8.45% p.a. You will get the security at a price that its yield to maturity is 8.45% p.a. Remember the coupon will still be 8.5% per annum. Just that you will get the security at a higher price (higher than face value) so that your yield is lower at 8.45% p.a.

You can make just one bid during an auction.

Go through these FAQs on Non-Competitive Bidding on the RBI website.

I have shared the results of a G-sec and T-Bill auction at the end of the post.

Taxation of Government Securities

As discussed earlier, Treasury Bills are issued at discount to face value. Since the treasury bills mature in up to 1 years, the resulting gains are taxed at your marginal income tax rate.

In the case of G-sec bonds, the interest is taxed at your marginal tax rate (tax slab).

As these Government bonds will be listed on exchanges, if you sell before completing 1 year, the resulting capital gains shall be taxed at your marginal tax rate.

If you sell after completing 1 year, the resulting capital gains shall be considered long-term capital gain and shall be taxed at either 10% without indexation OR 20% with indexation, whichever is lower.

If you hold the bond till maturity, there shall be no capital gain if you purchase the bond at par (at face value). However, if you purchased the bond at discount to face value, you will still have to incur the tax liability.

Any loss can be used for set-offs.

I have read different accounts of how these gains will be taxed. Do consult your Chartered Accountant for better clarity.

What are the benefits?

1. You get a debt product without any risk of default. After all, the Government can always print its own currency. Therefore, you don’t have to worry about the safety of your money.
2. You get a guaranteed income stream for the tenure of the Government bond.
3. You can lock in the rate of interest for the very long term. You will not find bank fixed deposits of more than 10 years. PMVVY is 10 years, SCSS is 5 years. Government bonds are available even with maturities of 40 years.
4. TDS is not deducted on interest payments. With SCSS and bank fixed deposits, TDS is deducted once the interest amount crosses a certain threshold. TDS can cause unnecessary operational hassles, especially if you fall in the lowest tax bracket.
5. From what I have observed, The G-Sec rates for the longer term are higher as compared to bank fixed deposits. G-Sec rates will be lower as compared to SCSS.
6. With annuity plans, you can lock-in interest rates for life. However, the annuity rates are quite low. The annuity rates will typically be lower than G-sec unless we are talking about a very old investor. I am talking about annuity plans with the return of purchase price.
7. Moreover, since the annuity rates depend on your age, a younger person will get a very low annuity rate. No such issues with G-Secs. The interest rate on Government bonds is the same for everyone.
8. While you can argue over the utility of an income stream (from investments or from an annuity plan) for a young person, some investors can find merit in such long-term Government bonds. At the same time, such investors can also consider high-quality corporate bonds and NCDs for better yields. However, these investors may not get as much choice with the bond tenures (as they would get with Government bonds).
9. You can pledge these securities to get a loan.

What are the cons?

1. Liquidity is a major issue. For now, you are stuck till bill maturity. There is no way for you to exit (sell) these bonds in the secondary market since the bonds are not yet listed.
2. Even though you can expect such Government bonds to get listed on exchanges soon, that will still not guarantee liquidity in the bond. For you to sell, there has to be a buyer who wants to buy at the price you want to sell.
3. Zerodha, on its website, mentions that it will play the market maker if you cannot find a buyer for these bonds. However, I am not sure of the deal they will offer you. Moreover, a lot depends on if Zerodha can onward sell such bonds to another investor. I doubt Zerodha would want to (or can) hold such bonds on its books.
4. The interest payments are taxable at your slab rate. For investors in 20% or 30% tax bracket, the net return can be much lower. There may be better tax-efficient ways to generate regular income. Systematic withdrawals from debt mutual funds can present a better tax-efficient alternative (albeit with higher risk).
5. Locking in interest rate can work both ways. You may end up locking in a low rate of interest.
6. Government bonds may not carry credit risk. However, such securities still carry interest rate risk. Longer the bond maturity, the higher will be its duration, a measure of rate sensitivity. Therefore, you may see price fluctuations in your Government bond portfolio based on rate movements. Be prepared for that. However, if you have invested to hold the bonds till maturity, these price fluctuations shouldn’t bother you. You will keep getting the contracted coupon on a semi-annual basis.
7. You get the money (coupon) back at regular intervals. Therefore, your money does not compound (unless you keep reinvesting the amount).
8. For traders, bond mathematics can get a bit complex. Go through the basic terms and methodology on the RBI website.

How to purchase Government bonds?

Even though I didn’t make a purchase, the process of buying through Zerodha and NSE goBID looks quite easy.

With NSE goBID, you have to register on the website using your PAN, e-mail, mobile number, broker and demat account details. For details about registration, go through this link. Subsequently, you have to place a bid (non-competitive) for bonds or T-Bill of your choice and make the payment. After allocation, the bonds/T-bill will be directly credited to your demat account.

With Zerodha, the process looks even simpler. You need to have a trading and demat account with them. Therefore, it is as simple as purchasing stocks. The funds for purchase will be debited from your trading account. Here is a snapshot available on their website.

You can expect other brokers to start offering this facility soon.

What should you do?

In my opinion, it is good that retail investors have an option to purchase Government bonds.  There are no two ways about it.

You will have to see if and how these investments add value to overall financial planning.

By the way, investing directly in Government bonds is not the only way to eliminate credit risk. You can use your PPF account smartly to generate tax-exempt and risk-free pension. There are debt funds that invest solely in Government Securities (gilt funds).  Very risk averse investors can consider these too. There won’t be any liquidity issues either as you can always sell back to the AMC.

There are two types of Gilt Funds available as per SEBI categorization rules.

1. Gilt Fund (no restriction on duration, effectively a dynamic bond fund)
2. Gilt Fund with 10-year Constant duration

Earlier, we used to have short-term gilt funds. Unfortunately, the category died after SEBI categorization rules. However, since there is no concept of providing regular income in case of mutual funds (except by way of SWP), price volatility due to rate movements will complicate matters for you.   Dividend option (because of DDT) is not a very cost-efficient method for long-term debt investments. If you are not looking for regular income, investing in such debt mutual funds and PPF is a better choice. 

You must understand, by foregoing credit risk, you may also be foregoing extra income that you can get. Personally, I wouldn’t want to eliminate credit risk completely from my debt portfolio. There are debt mutual funds which carry low credit risk and carry low volatility. Such funds are a good option to generate regular income.

Liquidity is an issue. At the moment, the bonds are not even listed on the exchanges. Hopefully, this will happen soon.  Even after that, you can’t be sure of the liquidity. It may take some time before retail bond markets become vibrant. Therefore, if you are buying these bonds to play on interest rate movements, do consider these aspects.

If you are looking to build a Hold-till-maturity portfolio to generate risk-free retirement income, allocating some portion to Government bonds may be a good choice. Do remember liquidity can still be an issue if you need your funds back in case of an emergency.

With T-bills (maturity up to 1 year), you need to think through your reason for investing in these T-bills. Since T-bills are not liquid for you, you can’t keep your money for emergencies in these T-bills. To meet emergencies, I would prefer liquid funds instead. If you are too risk averse, you can invest in a liquid fund that invest only in Government securities. You can also get better taxation in case of liquid funds.

Would you invest in T-bills and G-sec bonds? Do let me know in the comments section.

Snapshot of Auction result for G-Sec Bonds and T-bills from RBI website

Additional Read

Government Securities Market in India: A Primer (RBI)

Primer on Government Securities on Zerodha website

RBI Circular dated November 23, 2017: Auction of Government Securities: Non-Competitive Bidding Facility to retail investors

Non-competitive Bidding Facility for Dated Securities and Treasury Bills of the Government of India (updated on November 23, 2017)

FAQs on Non-Competitive Bidding

7.75% Government of India Savings (Taxable) Bonds, 2018

Credit and Thanks: Inputs from Mr. Udbhav Shah, SEBI Registered Investment Adviser