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How Retail Investors Can Buy Government Bonds

Oct 13, 2020 12:22 PM 6 min read

In July 2020, SEBI Chairman Ajay Tyagi proposed to move the trading of Government securities (G-secs) exclusively to a single platform, preferably stock exchanges, to simplify and unify the trading infrastructure of corporate bonds and G-secs.

Add to that, recent reports suggested that RBI and Clearing Corporation of India Ltd. (CCIL) are working on a system to make trading on G-secs and corporate bonds easier by "non-institutional traders and investors". The underlying intent appears to be fairly clear - to enable heightened retail participation in the bond markets, specially for Government bonds.  

It's difficult to follow along this dialogue without a bit of context first... 

What are Government Securities?

G-Secs are a type of debt instrument that are offered by governments to raise funds. 

What this means is that the Government issues these securities to be bought by market entities in return for which the latter receive "coupons" or specified interest rates (payable annually or semi-annually).


Why are They Important?

Let's say the Government is facing some fiscal distress and needs to resolve it. It will have the RBI issue some guaranteed risk-free bonds for sale in the market which, as suggested, are very lucrative because not many securities have the unwavering sovereign commitment that a G-sec offers.

Once the market invests, the Government will pay the buyers interest on those securities until they are redeemed at maturity when the buyers get the "face value" (original purchase price) and any remaining interest payout. 

There is also another component called "yield". Usually, it means the return that an investor realises on a bond purchase. Intuitively, it is somewhat similar to interest or coupon but more precise calculations for bond yields will include the compound interest payments, time value of money and the trading price of the bond. We’ve conjured simple explainers just for you - here and here.


How Do They Operate?

So, there are different categories of G-Secs.

  1. Treasury Bills (T-bills)

These are short-term instruments issued in three different tenors (91 days, 182 days, 364 days). They pay NO interest. They are simply issued at a discount and redeemed at face value at maturity. 

For instance, a 91-day T-bill with ₹100 face value is issued at ₹98.20. So, you buy it at a discount of ₹1.80 and get back ₹100 at the end of 91 days. 

  1. Cash Management Bills (CMBs)

These were introduced in 2010. They have similar features as the T-bills but are issued for a lesser tenor period than 91 days.

  1. Dated G-Secs

These have a fixed or floating interest rate that is computed and paid bi-annually on the face value. Tenor between 5 to 40 years So, long-term instruments. They include Floating Rate Bonds, Indexed Bonds, Special Securities (issued to OMCs, Fertiliser companies, FCI, etc.) and STRIPS (created out of existing securities).

Traditionally, G-Secs have largely been inaccessible to retail investors, owing to the complexity involved in the process of investing in one.


Should a Retail Investor Invest in G-Secs?

From the Government's standpoint, the idea of lifting retail participation is easy to understand as it quite simply increases the access pool. However, from a retail investor's standpoint, it is a far nuanced discussion. 

If your goal is to secure regular income while seeking capital preservation, G-Secs offer an interesting investment alternative. Here are some of their features:

  • Maximum safety of investment - G-Secs carry sovereign guarantee, implicitly suggesting a low probability of default i.e. High capital preservation narrative. They are available in a wide range of maturities and can sit with investment objectives that are designed for short term, mid term and even the long-term.
  • Alternative to Fixed Deposits (FDs) - FDs have traditionally been an extremely popular investment product owing to their perceived safety. However, in recent times, FDs have lost some of their shine with banks and NBFCs running into trouble. This swayed people in the direction of G-Secs. In fact, 10 year G-Sec yields have been somewhat converging to FD rates! 
  • Liquidity challenges - One of the downsides of investing in G-Secs lies in the difficulty in exiting the investment before the bond matures.Technically, one can sell the bond in the secondary market (similar to stocks). However, the GSec market is not nearly as liquid. In fact this is one of the reasons that lofty efforts are being made to enable simplicity for G-Sec investors which should drive an uptick in secondary market liquidity. 
  • Low cost and transparent sale process - The process of actually investing in bonds is fairly transparent and does not come with high costs. Additionally, brokers are easy to reach out to.
  • G-Secs are stored in your demat account, similar to stocks.
  • Readily available as they are held widely by all prominent banks and other investors too.


But, There's A Catch!

G-secs are currently issued through auctions conducted by RBI. Retail investors cannot bid directly without engaging brokers.  

So if you wanted to purchase these securities, you would have to buy them on an intermediary platform. You, as an individual, can't invest in them directly.  


You See the Issue Now, Don't You?

Commercial banks make up a little less than half of all G-sec investments, followed by Primary Dealers (PDs) and institutional investors like insurance companies. Even Mutual Funds, Cooperative Banks, Provident and Pension Funds are slowly picking up the pace. 

If you are a retail investor looking to purchase just modest units of G-Secs, you can either do it through broking platforms like Zerodha or through the mutual fund route. 

Mr. Tyagi, however, is advocating issuing G-Secs to interested investors directly in demat form! 

The Government reportedly plans on borrowing ₹12Lcr ($163.6bn) this financial year, which is a stupendous possibility, but sensible in light of the COVID-related contingencies and resulting fiscal deficit. 

If a regulatory overhaul of such nature allows easy access for the public to Government bonds, it would boost the sovereign's fundraising abilities and commensurately its ability to overcome budget deficits. 


Challenges to the Proposed Overhaul

There must be a reason why the above embargo exists, mustn't there?

Firstly, bond investing is not an easy concept to grasp. If retail investors are allowed to participate in RBI auctions directly, it would presumably be too daunting for them.

The inverse relation of the price with yield that is characteristic of Government bonds, is tricky. Plus, the impact of inflation, unemployment, benchmark rates, etc on G-Sec yields are all fairly technical principles to account for. 

Moreover, if you're investing in a dated G-Sec (like FRBs), the changing coupon rates may be difficult to keep a tab on. 

Secondly, considering the perceived permanence and safety of G-Secs, it might underestimate the liquidity risk that G-Secs carry especially for individual investors looking to dabble with them. 

One shouldn't be denied their right to exit an investment before the bond matures. But when one does so, it adversely impacts the future saleability of G-Secs in the secondary market because there aren't usually many takers.

Third, a primary motivation for people to buy securities is to use them as collaterals. This isn't possible for G-Secs because there are no provisions to pledge them in return for loans. However, they can be used as collateral to borrow funds in the repo market. 


This Isn't an Original Proposition, Is it?

In 2012, IDBI Bank launched the country's first online retail G-Sec Portal. 

In 2017, RBI notified that stock exchanges could act as aggregators for access and non-competitive bidding over G-Secs.

In 2018, online broking firm Zerodha launched a digital platform for retail investors to buy G-Secs, with a minimum investment of ₹10,000 ($136).

Around the same time, NSE India launched an online app called goBID, to buy and sell G-Secs.


Lack of Procedure or Lack of Popularity?

It seems like accessibility of G-secs is not alien to procedural improvement and progress so far. What exactly are Mr. Tyagi's concerns, then?

The most expected reason why G-secs aren't gaining investment momentum is due to their complexity, which is perhaps what sways people towards FDs, which are similar in character. 

So, in spite of regulatory eases in places, it might take a while for G-secs to gain mass approval. SEBI's suggestion to offer them in the same manner as other public offers of bonds and shares could be helpful. 

Most importantly, liquidity in the secondary market for G-secs needs a filip with the help of liquidity-enhancement schemes and market makers. Zerodha is planning to step in as one very soon. 

Let's see how that turns out!


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