Government Bonds in India- Types, Investment Procedure, Advantages & Disadvantages
Jun 23, 2020

Government Bonds in India- Types, Investment Procedure, Advantages & Disadvantages

The Central or the State Government often require additional funds for developing their infrastructure or avoid a liquidity crisis. In such a situation, they issue government bonds to tide over the condition and support further spending and obligations. These bonds act as a contract between the issuer and investors, wherein the issuer promises an interest on the face value of the debt instrument. The government also guarantees to repay the principal amount of bonds to investors on a stipulated date. So, we can say that investing in government bonds is a low-risk venture, as the issuers promise to repurchase them after a specific period.

Government bonds in India are a part of G-Sec (government securities) profile and usually continue for as long as 5 to 40 years. If the State governments issue these bonds, then they fall under the category State Development Loans (SDLs). In the beginning, only influential players in the government circle like large-scale companies and commercial banks could release G-Sec. However, the GOI finally made amendments to allow smaller players like individual investors and co-operative banks also to release these investment tools.

What are the different types of government bonds in India?

Detailed below are the various types of government bonds in India.

Fixed-Rate Bonds

The fixed-rate bonds issued by the government, as the name implies, offers a fixed rate of interest. It remains constant throughout the tenure, regardless of market fluctuations. Details of these investment tools remain clearly mentioned in the nomenclature. For example, 8%GOI2020 implies, the issuer of this bond is the Government of India, the maturity year is 2020, and the rate of interest on the face value is 8 per cent.

Floating-Rate Bonds (FRBs)

Unlike the fixed-rate bonds, the rate of interest in the floating-rate bonds (FRB) keeps on revising periodically. The issuer declares the intervals after which the change of rate will become applicable. If the pre-announced duration of an FRB is three months, then it suggests that the issuer will revise the rate of the bonds after every three months. The interval remains fixed for the entire tenure of bonds. In some cases, there is a base rate and a fixed spread for an FRB. Here an auction decides the valuation of these two components, and it remains constant throughout the term.

Sovereign Gold Bonds (SGBs)

In the Sovereign gold bonds, traders can invest in gold for a prolonged time in the paper form. The Central Government issues these bonds, and the interest also gets exempted from tax. Investors can earn an interest of 2.5 per cent on these schemes for 8 years (unless mentioned otherwise). The profit gets periodically disbursed to the accounts. The prices of these investment tools remain equivalent to the cost of physical gold. The issuer calculates the value of SGB by taking the average of closing prices of 99.99% purity gold for three days preceding the launch of these schemes.

SGBs are beneficial gold investments as it relieves the burden of investing in physical gold. However, RBI has fixed guidelines and regulations concerning the possession of these bonds:

  • Undivided families or individual investors can own up to a maximum of 4 kg of Sovereign Gold Bonds in a financial year.
  • Trusts, universities and other charitable institutions, on the contrary, can possess 20 kilograms of SGBs during a year.
  • If you wish to redeem these bonds, then you have to wait for a minimum of five years. The redemption comes into effect on the day of the next interest disbursal. For instance, Mr X purchase an SGB on 01st March 2010, and the interest disbursal is scheduled on 01st April 2010, and after every six months in the succeeding tenure. Suppose, Mr X, decides to withdraw the SGB on 15th June 2015, but he has to wait until 01st October 2015 to generate the withdrawal value.

Inflation-Indexed Bonds (IIBs)

Inflation-indexed bonds are a unique investment tool where the principal and the interest get calculated according to the inflation rate. The IIBs are primarily released for retail investors and get indexed according to the Wholesale Price Index (WPI) or Consumer Price Index (CPI). These bonds safeguard the portfolio of traders as the returns remain constant. Capital Indexed Bond is a variation of IIB, where only the principal value gets calculated according to the inflation rate.

7.75% GOI Savings Bonds

In 2018, a variation of G-Sec came into effect after the discontinuation of the 8% Savings Bonds. As implied in the nomenclature, the rate of interest in this government Bond is 7.75 per cent. According to the Income Tax Act 1961, the interest earned through these bonds is taxable. The minimum value of this investment tool is either 1000 or its multiples. RBI has a set of guidelines for owning these G-Secs:

  • NRIs cannot hold these bonds.
  • A minor can purchase this G-Sec if he/she has a legal guardian representative.
  • Residing Indians can hold this bond.

Bonds with Call or Put Option

Bonds with Call or Put options are a unique type of G-Secs where the issuers and investors exercise right to either buy-back them or sell them to issuer respectively.

  • In the call-option only bonds, issuers can only repurchase them.
  • Similarly, in the put-option only bonds, investors can sell them at will to issuers.

However, these transactions are possible only after 5 years of the date of issue. The buy or sell of Bonds with Call or Put options becomes effective from the date of interest disbursal.

Zero-Coupon Bonds

Zero-Coupon Bonds do not offer interest to investors. However, you can generate earnings through the difference in the issuance price and redemption value. These bonds are not raised through auctions. They develop from existing securities.

How to buy government bonds in India?

  • Similar to all other transactions concerning equities, investors require a Demat account for trading in government bonds.
  • However, these bonds are not available at stock exchanges.
  • You need to visit the post offices or leading banks to purchase G-Secs. Investors need to attach their identity and address proof (PAN Card, Voter ID, Passport, Aadhar Card, and Demat account number) while applying for these schemes.
  • After the submission of the application form, a minimum procession time is required for the verification of documents. After the completion of all formalities, a G-Sec gets issued in the name of the applicant.

What are the advantages of government bonds?

Sovereign Guarantee

Government bonds are a safe mode of investment as the issuer guarantees to repurchase them at the end of the tenure. They are a part of the government’s debt obligation, so the issuer is liable to repay the face value as per pre-decided terms on the maturity date. It is an excellent option for freshers in the equity market as there is ample stability and assured returns in these funds.

Inflation Adjustment

The Inflation-Indexed Bonds under the G-Sec category remain adjusted according to the average price level of the market. It is a practical approach for retail investors as they remain less susceptible to financial issues even if the real value of the funds changes considerably.

Constant Income

The Reserve bank of India has issued guidelines that the issuers of government bonds should disburse regular interest on the same after an interval of every six months. These schemes act as a constant income source for debt holders, who can productively utilise their idle fund.

High Liquidity Value

Since banks and other financial institutions issue government bonds, these investment portfolios enjoy a high liquidity value.

Tax Benefits

Some long-term government bonds (tenure more than ten years) enjoy absolute tax exemption as per Section 10 of the Income Tax Act of India, 1961. You can save on your income tax by investing in G-Sec schemes.

What are the disadvantages of government bonds?

Low-Interest Rate

Compared to all other investments in the equity market, the interest earned through GOI Savings Bond remains capped at 7.75 per cent. It is relatively lower than other bonds and schemes.

Loss of Relevancy

The tenure of G-Secs ranges from 5 to 40 years. In most cases, these bonds loss their relevance after the maturity date considering the inflation value. However, Inflation-Indexed Bonds and Capital Indexed Bonds are exceptions to this as they follow the inflation trend concerning their face value.

Frequently Asked Questions

1. What is the 10-year government bond yield?

The India 10 Years Government Bond reached a maximum yield of 8.182% (11th September 2018) and a minimum yield of 5.772% (10th June 2020)

2. What are tax-free government bonds?

Tax-free bonds are issued by a government enterprise to raise funds for a particular purpose. One example of these bonds is the municipal bonds. They offer a fixed interest rate and hence is a low-risk investment avenue. As the name suggests, its most attractive feature is its absolute tax exemption as per Section 10 of the Income Tax Act of India, 1961. Tax-free bonds generally have a long-term maturity of ten years or more. The government invests the money collected from these bonds in infrastructure and housing.

3. Can NRIs buy Indian government bonds?

Yes, as per the recent guidelines of the RBI, NRIs can hold specific Indian government bonds taking the help of ‘Fully Accessible Route’ (FAR). This change in directions has become effective from 1st April 2020.

4. What are the best government bonds to invest in India?

Some of the perfect government bonds to invest in India are

  • 7.75% GOI Savings Bond
  • Sovereign Gold Bond (SGB)
  • Capital Gains Bonds by NHAI & REC
  • Indian Railways Finance Corporation (IRFC) Tax-Free Bonds

5. Is it safe to invest in government bonds?

Yes, it is safe to invest in government bonds as the Central or the State Government enterprises launch these bonds. Moreover, the RBI supervises the proceedings of these schemes, so they are risk-free, regular source of income for investors. The issuer also guarantees to repurchase the G-Secs after the completion of tenure.

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