Personal Finance

Investing In India: What Are Government Bonds?

Indian government bonds, commonly referred to as government securities or G-Secs, are debt securities issued by the Indian central government or Indian state governments. When you buy Indian government bonds, you are a creditor who is loaning money to the government. Indian government entities sell G-Secs to fund their operations and build out roads, schools and other infrastructure projects.

How Do G-Sec Government Bonds Work? 

In India, short-term G-Sec bonds with a maturity of less than one year are referred to as treasury bills, or T-bills. Treasury bills are available with a maturity period of 91 days, 182 days and 365 days.

G-Sec bonds with a maturity of one year or more are long-term securities, referred to as government bonds. 

The Indian government issues both T-bills and government bonds, while Indian state governments issue only bonds called the State Development Loans (SDLs). 

G-Sec Auctions

The government auctions T-bills and government bonds. It announces auction dates and bond sales ahead of time, and discloses the amount of securities it intends to sell. Two auction processes are employed: yield-based auctions and price-based auctions. 

An investor who purchases a bond can expect to receive a return from either: 

  • The coupon interest payments made by the issuer.
  • Any capital gain (or capital loss) when the bond is sold/matured.
  • Income from reinvestment of the interest payments that are interest-on-interest.

Coupon Yield: This is the coupon payment as a percentage of the face value and refers to 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. 

The price of a bond is the sum of present value of all future cash flows of the bond. The interest rate used for discounting the cash flows is the Yield to Maturity (YTM) of the bond. 

In a yield-based auction, new G-Secs are sold. 

In a price-based auction, the government reissues securities issued earlier.

Participation in G-Secs

Generally, buyers of G-Secs include banks, primary dealers, financial institutions, mutual funds and insurance companies, who bid either in terms of a coupon for a new bond or the price for an existing bond being reissued. 

Until 2001, only institutional investors could bid for government bonds. The market was deregulated at that time, opening up auctions to other buyers. Today, retail investors can participate in government bond auctions via noncompetitive bidding up to 5% of the specified amount the government seeks for the G-Sec issuance. This means if the notified amount by the government is INR 1,000 crore, the amount reserved for noncompetitive bidders or retail investors would be INR 50 crore and the remaining INR 950 crore will be put up for competitive auctions.

Retail investors include individuals, companies, corporate bodies, institutions, provident funds, trusts and any other entities permitted by India’s central banking regulator the Reserve Bank of India (RBI). Retail investors need to have a current account or a Subsidiary General Ledger (SGL) account with the RBI to participate in the auction process. 

Any investor who has a demat account or is a RBI-approved investor can also participate in the noncompetitive bidding. 

Returns on G-Secs

The way to measure your return on a G-sec is to evaluate the yield to maturity. 

The Yield To Maturity (YTM) refers to the effective rate of interest paid on a bond if you buy and hold the bond till its maturity date. The yield on government securities is influenced by various factors such as: 

  • Inflation
  • Level of money supply in the economy
  • Future interest rate expectations
  • Borrowing program of the government
  • Monetary policy followed by the government

The calculation for YTM is based on the rate of interest or coupon rate, length of time to maturity and the market price. 

The present value of the bond is calculated by discounting each cash flow at a rate; this rate is the YTM. Thus, YTM is the discount rate which equates the present value of the future cash flows from a bond to its current market price. In other words, it is the internal rate of return on the bond. 

The rate of interest or the coupon rate is fixed through a market-based price discovery process. The price of a bond in the markets is determined by its demand and supply and is estimated based on the measure of the yield of the G-Sec.

Treasury bills, on the other hand, are zero coupon bonds and are issued by discount and redeemed at face value.

Taxation on G-Secs

Interest income from government bonds is taxable depending on the holder’s income tax bracket  under the Income Tax Act. Gains from the sale of bonds are taxed as either long-term capital gains or short-term capital gains, depending on how long the bonds were held.

Proceeds from the sale of G-Secs held for a period of 12 months or less are treated as short-term capital gains, taxed at the holder’s marginal income tax rate. 

On the other hand, G-Secs held by the taxpayer for a period of more than 12 months are treated as long-term capital gains. The tax on these long-term capital gains can be minimized by factoring indexation, which is a process by which the cost of acquisition of an asset is adjusted or recalculated against inflationary rise in its value. 

The inflationary rise can be estimated by the inflation index published by the IT department and is based on the: 

  • Year of acquisition/improvement of the asset
  • Year of transfer of the asset
  • Cost inflation index of the year of acquisition/improvement of the asset
  • Cost inflation index of the year of transfer of the asset

In India, only long-term capital assets enjoy the benefit of indexation. Bondholders have a choice between availing the benefit of indexation or not and are taxed based on that.

  1. If the bondholder avails the benefit of indexation, the long-term capital gains will be charged at a normal rate of 20% (plus surcharge and cess as applicable). 
  2. When the bondholder does not avail the benefit of indexation, the long-term capital gains so computed is charged to tax at 10% (plus surcharge and cess as applicable).

Advantages of Owning Indian Government Bonds

Indian government bonds are a highly secure, low-risk investment. G-Secs are backed by the full faith and credit of the Indian government, meaning that you are all but guaranteed coupon payments and the return of your principal investment upon maturity.  

G-Secs are generally held in demat accounts, which provide a very high level of security for your investment. If you want to hold them in the physical form, the government will issue you physical certificates. 

With a wide range of maturities available, from 91 days to  40 years, investors can choose G-Secs that meet all their risk and time horizon requirements.

G-Secs Can Be Used as Collaterals for Loans

G-Secs can be used as collateral against short-term loans and to borrow funds in the repo market.

In repo markets, securities are exchanged for cash with an agreement to repurchase the same securities at a future specified date at the end of the contract. The price difference between the payment for the security at the beginning of the repo contract and the payment received by the buyer at the end of the contract is the return that they make on the transaction. 

G-Secs Trades Settlement is Simple

G-Secs can be sold in the secondary market, where investors purchase and sell securities among each other, to meet cash requirements. The settlement system for trading in G-Secs is a system based on a method called Delivery versus Payment (DvP). This is looked at as a simple system of settlement of securities. 

The way DvP works is that the seller transfers securities simultaneously with the transfer of funds from the buyer of the securities thereby mitigating the settlement risk.

How To Trade G-Sec Government Bonds

There are five different ways to buy and sell G-Sec government bonds.

1. G-Secs Auctions via RBI’s Electronic Auction Platform

G-Secs auctions are conducted on the RBI’s e-Kuber electronic auction platform. Market participants such as commercial banks, primary dealers, insurance companies and provident funds maintain current account or securities accounts with the RBI, which allow them to participate in electronic auctions. 

2. G-Secs Auctions via Commercial Banks

If you don’t have access to the e-Kuber platform, don’t worry, you can participate in primary auctions via scheduled commercial banks or Primary Members (PMs). To participate in such an auction, open a securities account with a bank or a Primary Dealer (PD). This account is called a Gilt Account. A Gilt Account is a dematerialized account maintained with a scheduled commercial bank or a PD. 

All G-Sec transactions undertaken by PMs are settled through accounts maintained by them with RBI. The G-Sec transactions in G-Secs undertaken by gilt account holders via PMs are settled through Constituent Subsidiary General Ledger (CSGL) account maintained by PMs with RBI.

3. Buy G-Secs on the Stock Exchange

The Bombay Stock Exchange’s (BSE) platform BSE Direct allows retail investors to bid for G-Secs. Noncompetitive bidding is also permitted via BSE’s new online bidding platform “NCB-GSec” for collecting bids from members on behalf of their clients. 

The National Stock Exchange of India allows retail investors to purchase G-Secs by placing an order through any one of the following options available under the noncompetitive bidding facility offered by the exchange.

4. Buy G-Secs on a Broking Platform

Stock brokerage platforms such as HDFC Securities and Zerodha offer retail investors an option to buy G-Secs directly via their internet trading platforms available on their mobile apps. 

5. Purchase G-Secs via Mutual Funds 

Gilt mutual funds help investors invest in G-Secs issued by the Government of India. Investors can choose Gilt Funds based on the number of years they want to hold the security and based on the nature: long term or short term. 

Some popular Gilt Funds available for investors to trade in G-Secs for a period of 1-year include:

Long-term G-Secs

  • ICICI Prudential Gilt Fund
  • SBI Magnum Gilt Fund
  • HDFC Gilt Fund

Short-term G-Secs

  • UTI Overnight Fund
  • SBI Magnum Constant Maturity Fund
  • IDBI Gilt Fund

Investors in India can hold G-Secs as: 

  • Physical security 
  • Subsidiary General Ledger (SGL) account with the Public Debt Office of the RBI.
  • Constituent SGL accounts with banks who hold G-secs on behalf of the investors in their SGL-II accounts of RBI, meant only for client holdings.
  • Same demat account as is used for equities at the Depositories. Both NSDL & CDSL hold G-Secs in their SGL-II account of RBI, meant only for client holdings.
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