Last Updated on Dec 9, 2022 by
To meet its budget requirements, apart from using tax funds or borrowing from banks and Non-Banking Financial Companies (NBFC), the Government raises funds by issuing securities such as bonds to investors. The proceeds from the sale of government securities (G-secs) are used in nation-building, infrastructure development and other works. After the maturity of the bond, the investor receives the principal amount along with interest.
From an investor’s perspective, government securities are one of the most secure forms of investment instruments with minimal risk. In this article, let’s learn about government securities, how to invest, types, and their pros and cons.
Table of Contents
What are government securities in India?
Government securities are a type of financial instrument where investors can park their extra savings to earn a fixed interest and grow wealth over time. There are various types of government securities, such as treasury bills, bonds, and notes, among others. Also, government security is a debt instrument.
That is, as an investor, you provide a loan/debt to the government so that it can fund its projects. Both central, as well as state governments issue bonds in order to meet their budgetary expenses. The investor’s money is safe with the government, and the investors get a fixed interest on the capital invested.
Why does the government issue securities?
Government securities are a debt financing option for the government. The government uses securities like bonds to raise funds to expand its operations and build infrastructure. One example is buying supplies from the farmers, building roads, and completing other infrastructure projects such as metros, highways, and railway lines. These projects require a large amount of capital, which the government funds by issuing bonds to the general public.
Governments also borrow money from banks and other non-banking financial institutions. However, banks charge a hefty interest rate on loans. Raising funds using its securities is cheaper for the government.
Who can invest in government securities (G-sec)?
Earlier, only banks and other financial institutions were allowed to buy and hold government securities. But, since 2001, the norms have been relaxed, and retail investors can hold 5% of the funds. These retail investors can be institutions or individuals.
Usually, the bonds are issued by auction. Therefore, only banks and other large financial institutions can bid for the bond auction. After bidding in the primary market, the bond comes into the secondary market for trading. This is when retail investors can get their hands on government securities as an investment.
Types of government securities in India
Government securities are often considered risk-free and make excellent investment opportunities for risk-averse investors or even for more daring investors looking to diversify their risk. Here are the types of government securities available in India.
Treasury bills (T-bills)
Only the central government can issue T-bills. These are money market instruments with a maturity period of less than one year. The government issues three types of bills, with a maturity period of 91, 182, and 364 days. Investors can choose one depending on the liquidity they want.
The most important thing to note is that T-bills do not pay any interest to the holders. Investors buy T-bills at a discounted rate to make money in the market and sell at a premium.
Cash Management Bills (CMB)
Launched in 2010 by the Government of India and RBI, these are comparatively newer money market instruments used by the government to meet its short-term cash flow mismatches.
However, maturity is one factor where CMBs are different from T-bills. The maturity period, in this case, is less than 91 days. They are considered short-term investment products. Like treasury bills, they are issued at a discount rate. For example, you may pay Rs. 97 for an Rs. 100 bill and then redeem it at the maturity date for Rs. 100.
Long-term government securities
Unlike CMBs and T-bills, the maturity of these securities is longer than one year. They are popularly called dated government securities. The maturity of these securities typically ranges from 5 yrs to a maximum of 40 yrs. Investors also earn a fixed interest rate when they invest in government security. The interest rate can be both fixed and floating. Interest is received quarterly on the total amount of capital invested.
The nine types of G-secs provided by the Government of India are listed below:
- Fixed-rate bond – As the name suggests, the interest rate on this remains the same during the entire tenure.
- Floating rate bond – As the name suggests, the interest rate keeps fluctuating during the investment period.
- Capital bond – In this, the principal amount is linked to an accepted inflation index. In a capital bond, the investment is protected against inflation.
- Inflation index bond – The principal and interest are linked to an inflation index.
- Bonds with call/put option – These bonds come with an option where the issuer can buy the bond back, or the investor can sell the bonds back to the issuer. This option can be availed only after 5 yrs of the issue of the bond.
- Special securities – At times, the Indian Government issues special securities from fertiliser companies, food corporations of India, oil marketing companies, etc. These securities are issued as compensation to these companies instead of cash subsidies.
- Separate Trading of Registered Interest and Principal of Securities (STRIPS) – In this, the cash flow of a fixed-rate bond is converted into individual security and is traded in the secondary market.
- 7.75% GOI savings bonds – It was introduced in 2018, where the interest rate on this bond is 7.75%.
- Sovereign gold bonds – The price of this bond is linked to the price of gold. The value of the bond is calculated based on the previous week’s simple average closing price of 99.99% of purity gold.
State development loans (SDL)
The state development loan, as the name suggests, is issued by the state government. It is used to fund the state’s development projects and budgetary needs. The functioning of the SDL is similar to other government securities. The basic difference between them is that the state government issues SDL, and the central government issues the G-sec.
How to buy government securities in India?
With digitalisation, buying government securities and bonds in India has become simple and easy. You can buy G-sec through the following ways:
- Stock broker – Similar to buying stocks, you can buy government securities from a stock broker. Whenever there is a government bond issued, the stock broker updates their platform. You can buy these securities either in a non-competitive bidding process or through an auction.
- Mutual funds – You can buy government bonds through mutual funds as well. You don’t have to explicitly decide on which G-sec to purchase. The mutual fund provider will pick a bond according to your investment requirements. However, ensure to check the portfolio allocation for the government bonds and the bond duration.
- Directly – You can also buy government securities directly from the NSEGoBID Platform or RBI Retail Direct websites. Complete the formal registration process and place a bid for your preferred securities.
Features of government securities
- Most government securities are issued at their face value, and no premium is added to the price.
- Government securities guarantee fixed income to the investors.
- The liquidity of G-sec in the secondary market is high as compared to the primary market. Therefore, retail investors get high liquidity in the secondary market, and you can directly sell in the secondary market.
- No tax is deducted at the source in the case of government securities.
- The premium, face value, and interest rate are fixed at the time of issuance, and they can not be changed once the security is issued.
- Investors can store government securities in dematerialised format.
- In the case of redemption, the securities are redeemed at face value.
- The maturity tenure ranges between 2-30 yrs.
How do investors make money by investing in government security?
The return generation in the G-sec segment depends upon the type of G-sec investor chooses. Investors who want a fixed half-yearly income can choose G-sec with coupon rates.
Also, the investor can buy some of the G-secs at a discounted rate. They are redeemed at a premium at the time of maturity. Thus, investors can make money in these two ways by investing in the G-sec.
The G-sec or government bonds are issued by the Reserve Bank Of India (RBI) on behalf of the government. RBI focuses on reducing the fiscal deficit of the ruling party. Over the years, G-sec has gained a lot of popularity and attraction.
Advantages of Investing in government securities
- Returns: Government securities offer decent returns similar to bank deposits. They offer steady returns.
- Negligible risk: The risk on the government securities is negligible as it is backed by the government, and the chances to go default on interest or principal amount is very low.
- Liquidity: Due to its low-risk profile, the G-sec are highly liquid.
- Regular income: On most government securities, there is an interest offered to the investors every 6 months.
Risks of investing in government securities
There are two types of risk involved in G-sec.
- Credit risk: There is always a risk of non-payment of the principal amount and the interest rate. Although, in the case of government securities, the risk is almost negligible. But, investors should be diligent and always check third-party ratings before making any investment.
- Inflation risk: When inflation rises, the low interest on the bonds does not attract many investors. Therefore, inflation affects the purchasing power and viability of these instruments. However, inflation-linked bonds increase the investor’s principal and interest amount when inflation rises.
Tax on government securities in India
Similar to fixed deposits, government securities are not tax-free. The taxes on G-sec is as follows:
- On bonds and SDL: The interest credited to the bank account is considered income from other sources and taxed as per the income tax slab.
The returns are taxed as per the duration of the investment: - Long-term capital gains (LTCG) – the investment held for more than 1 yr are taxed at 10% flat
- Short-term capital gains (STCG) – the investments held for less than 12 months are taxed as per the applicable income tax slab rate.
Also, there is no TDS for the interest payments received for government securities. - T-bills: In the case of T-bills, the returns are considered STCG and taxed as per the applicable income tax slab rate.
FAQs
1. Is a Demat account mandatory to purchase government securities?
Yes. It is mandatory to hold a Demat account to purchase government securities in India.
2. Is investment in government securities safe?
The government securities are backed by the government. Hence it is considered a safe investment option when compared to other investments.
3. What is the interest on government securities, Floating Rate Bond (FRB)?
The interest rate provided on the Floating Rate Bond is 7.69% p.a. from 7th December 2022 to 6th June 2023.
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