We give you the details of these bonds and tell you whether or not it makes sense to buy them.
Features of the bond
The bonds will have a tenor of seven years and the interest payment will be taxed at your income tax slab rate. They can be purchased from all nationalized banks and specified private sector banks, including HDFC Bank, ICICI Bank and Axis Bank. Only resident Indians or Hindu Undivided Families (HUFs) will be allowed to subscribe to these bonds.
The bonds have a minimum subscription of ₹1,000 and in multiples of ₹1,000, thereafter. There is no maximum limit. The interest rate on the bonds will be paid on 1 January and 1 July every year. The first interest rate payment will be made on 1 January 2021 at 7.15%.
The bonds will not be issued and held in your demat account, but they will be issued and held in an electronic bond ledger account.
The bonds cannot be traded or used as collateral for loans. However, they can be inherited by the legal heirs of the holder. Premature redemption will be available for senior citizens with the lock-in reduced to 4-6 years, depending on the investor’s age. Tax deducted at source (TDS) will be cut at 10% on the interest payments on bonds.
You can also reinvest the interest to buy fresh bonds in multiples of ₹1,000 to compound your money. However, these bonds will have a fresh tenor of seven years and will not be the same 7.15% bonds.
Should you buy?
Most financial planners favour the bonds. Kalpesh Ashar, founder, Full Circle Financial Planners and Advisors, highlighted the sovereign (government) guarantee behind the bonds, which makes them very low risk.
He added that the floating rate was a positive. A floating rate can adjust higher when overall rates in the economy go up. This can help bondholders in times of high inflation when interest rates are generally hiked. However, when interest rates head lower, the rates on the bonds will also be reduced.
But there are alternatives to the proposed bonds as well. These include the Public Provident Fund (PPF), NSC, Sukanya Samriddhi Yojana (SSY) and Kisan Vikas Patra (KVP). If you are a senior citizen, you can also invest in Pradhan Mantri Vaya Vandana Yojana (PMVVY) and Senior Citizens Savings Scheme (SCSS).
Among these, only SSY, SCSS and PMVVY currently offer higher rates than the proposed bonds. SSY offers 7.6%, while the other two give 7.4% each. However, SSY is only available for the parents of a girl child below the age of 10 and has a maximum deposit limit of ₹1.5 lakh per year. SCSS and PMVVY have a maximum limit of ₹15 lakh per person and are only available to senior citizens.
“Given the current situation, these bonds are a decent offering, considering the safety aspect and that there’s no upper limit for investment. People, especially senior citizens looking to park money in safer options for a long tenure and not requiring regular monthly income (payout is biannual) can consider them," said Prableen Bajpai, founder, Finfix Research and Analytics, a wealth management firm.
Another competitor to these bonds is debt mutual funds. Debt fund returns can fluctuate based on credit quality (the risk of default) and interest rate risk (bond prices changing when interest rates get revised). The bonds are relatively insulated from both these factors due to their government guarantee and six-monthly interest rate reset.
Another parameter of a comparison is the returns. Comparing the potential returns of debt funds, which are affected by credit and interest rate risk with a fixed rate product is difficult. However, a rough method of estimating debt fund returns is to look at their yield-to-maturity (YTM) minus expense ratio. The YTM for most debt funds, other than those taking on lot of credit risk currently is in the 5-6% range. Even if we take the expense ratio to be zero, this is a lot lower than the 7.15% on the bonds. At the shorter-end, debt funds have YTMs of 4-5%.
However, Kirtan Shah, chief financial planner, Sykes and Ray Equities (I) Ltd, said debt funds have certain advantages. “I think that interest rates have further room to drop, and then they will go up. This movement will be captured by both short-end funds like liquid and ultra-short as well as this product, but perhaps more efficiently by the funds," he said.
In addition, debt funds enjoy a tax advantage and are liquid, he said. Capital gains in debt mutual funds held for longer than three years are taxed at 20% and you get the benefit of indexation. On the other hand, the interest on these government bonds will be taxable at the slab rate. Also, open-ended debt funds can be redeemed on any business day. This is not possible in case of the bonds, which have a tenor of seven years.
Senior citizens in lower tax brackets who want a fixed income can consider them. However, they should be mindful of the lack of liquidity and the fact that they don’t not offer a monthly interest payout option.
For those who are still building up savings and don’t need regular income, a tax-free government savings instrument like PPF can deliver better value.