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Retail G-Secs are cool but who wants them anyway?

In a bid to clean up election funding, the government had in January introduced electoral bonds that can be bought from specified branches of State Bank of India and used to donate money to political parties. Photo: iStockphotoPremium
In a bid to clean up election funding, the government had in January introduced electoral bonds that can be bought from specified branches of State Bank of India and used to donate money to political parties. Photo: iStockphoto

Government securities now available to retail investors are not simple alternatives to bank deposits for various reasons including the fact that they can deliver either gains or losses.

Getting retail investors into any segment is the ultimate vindication of a market’s success, and hence the Reserve Bank of India’s (RBI) move to enable retail investment in government securities (G-secs) is noteworthy. We also talk of the same for India’s corporate bond and commodity derivative markets because having more players adds buoyancy. While allowing such an entry is good, the broader question is whether it will work.

As a saver, an individual looks out for three things: Safety (a matter of risk), return and liquidity. This is what has made people keep money in bank deposits even though they provide very low returns. Such savers are taken for granted and there is no lobby group to promote their interests. If one looks at the G-Secs market, all these factors will come into play as individuals review their options. Safety is a no-brainer when it comes to these bonds, as there is no question of a default under any circumstance. How about the other two?

When we look at returns, there is an inherent contradiction in the way our schemes have been formulated. The government already has in place small-savings schemes that are open to retail investors. One can go for various options offering better returns than government paper. The current returns on G-Secs are as follows: 10-year bonds give 6.1-6.15%, 5-year bonds 5.7-5.8% and 3-year ones around 5%. Post office deposits give 5.5% and 6.7% for 3 and 5 years respectively. National Savings Certificates (NSCs) yield 6.8%, while a Kisan Vikas Patra (KVP) which goes for 10 years provides 6.9%. The floating bond scheme gives 35 basis points more than an NSC, so that’s 7.15% now (it is reset every quarter). The government’s small savings options give higher returns because they are defined this way. A panel led by Usha Thorat had recommended that these schemes be priced at 50 basis points above G-Secs, which makes higher yields tautological.

Here, one is not talking of bonds issued by government-run agencies such as National Thermal Power Corp, National Highways Authority of India, etc, which offer higher rates than G-Secs. At times, there have been issuances of tax-free bonds that attracted retail investors in droves. Individuals are happy to hold these bonds.

The question of liquidity is important for individuals, as banks allow one to go in for premature withdrawals by paying a small penalty. This is among the reasons people have fixed deposits. Postal deposits can also be withdrawn before maturity, but the same does not hold for certificates (which can be liquidated early only under extreme conditions like death). What about G-Secs?

Like any saleable bond, G-Secs can be sold in the market at any time, as these are listed for trading right after their issuance. Holders need to recognize, though, that any deal in the secondary market will involve a gain or loss, and a rising interest-rate regime will get reflected in declining prices, which would mean a loss. It is not predefined, unlike for a deposit, on which 50-100 basis points may be deducted as a penalty.

The next big issue is whether it is easy to sell one’s holdings.

As of date, there are 95 government securities that are listed. However, not more than 4-5 have more than 100 transactions in a day. Another 30-40 would be recording less than 10 trades. The interesting thing about G-Secs is that the benchmarks tracked by the Fixed Income Money Market and Derivatives Association of India show reasonably good levels of trading, as their prices (and yields) serve as market signals. Here, it is the 1, 3, 5, 10 and 15-year benchmark bonds that usually make the mark. But the curious thing is that once a security ceases to be a benchmark, it moves to the background and is no longer actively traded. The market works on the basis of maturity or tenure, and after a year, a 5-year bond becomes a 4-year one and the market loses interest. So, a retail investor may get excited investing in, say, a newly-issued 6.10% 2031 bond, but would find it hard to sell after a year once it turns into illiquid nine-year paper. The only way this deal will work for the retail investor is if it is held to maturity. But then, a yield of 6.1% is lower than a KVP’s 6.9%.

Direct retail investing in G-Secs, as proposed, may not be a quick starter for all these reasons. Drawing individuals to the corporate bond market has been a challenge all along. Highly-rated bonds find subscribers when returns are good. But most of them would be holding the paper to maturity.

Buyers also need to understand market dynamics. If one buys a security, its price is important, as the investor gets its face value of 100 at maturity (besides two half-yearly payments of annual interest). If the 6.79% 2027 paper, say, is bought at 103.28 , one gets 100 in 2027. Bond math is not easy and requires a clear understanding, unlike the equities we’re all largely familiar with.

Retail investors already have access to G-Secs through various gilt schemes that are run by mutual fund houses. Here, they get exposure to a wider set of government securities, including dated paper as well as treasury bills, depending on the way the specific fund is structured. The investment and payoffs are professionally handled, as the fund manager takes care of all these issues. With this option being exercised with enthusiasm by individuals, does it really make sense to start buying G-Secs being issued? The answer is a big shoulder shrug.

Madan Sabnavis is chief economist, Care Ratings and author of ‘Hits & Misses: The Indian Banking Story’. These are the author’s personal views.

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