• HDFC
• 18 Jun 2018
• Knowledge Centre

HDFC, Tester

India’s debt market is divided into two main segments. One is that of Government securities (G-Secs), which includes central Government and State Government securities. The second is that of the corporate bond market. G-Secs are issued by the Reserve Bank of India (RBI) on behalf of the Government.

 

Although primarily used as a tool to help the Government borrow money from the market to fund their expenses and bridge the country’s fiscal deficit, G-Secs offer a host of other advantages to investors. Earlier, investors in this financial instrument were largely banks, financial institutions, and corporates. It opened up to retail investors after the country’s primary stock exchanges – the BSE and NSE – started playing the role of facilitator for non-competitive bidding (NCB) in the RBI auction in G-Secs and Treasury Bills (T-Bills).

 

Easing investment

 

In a move to boost the country’s retail debt market, the RBI eased the process for investment in G-Secs for overseas investors. The central bank has done away with the cap on investment that does not permit foreign portfolio investors (FPIs) to cross a certain level while investing. They have also done away with the constraint that the investment must be in a paper that has a minimum of three years to mature. This move is expected to markedly increase inflows from overseas investors.

 

A notice on the RBI website stated, “The minimum residual maturity requirement for central government securities and state development loan categories stands withdrawn, subject to the condition that investment in securities with residual maturity below one year by an FPI under either category shall not exceed, at any point of time, 20% of the total investment of that FPI in that category.”

 

Two routes available

 

Investment in G-Secs can be availed of via two routes – auctions that are competitive and those that are non-competitive. The latter is for small investors, while the competitive option is for large institutional investors like financial institutions, banks, and mutual funds, among others. Participation in these auctions takes place by placing bids directly with the central bank.

 

One big plus of this financial instrument is that it is a risk-free investment option, as the Government is the borrower. Apart from this, other advantages include the locking in of high yields (the quantum of returns on a debt security) and safety of the principal amount. Returns are at par with those of bank deposits, or better in some cases, and have a longer tenure. Also, interest rates are on the upside. The 10-year G-Sec rate has risen 150 bps over the last one year. Hence, an investor with a long-term investment horizon can invest in 10-year G-Secs to lock into the current high rates.

 

Tax-efficient option

 

“However, there is a possibility that retail investors will find it easier to opt for investment via the mutual fund route. One reason being that it is a more tax-efficient option as compared to G-Secs. Direct investment in G-Secs will result in an annual interest payment which is taxed at the maximum rate. In the case of Gilt funds, the NAVs rise (in the growth option) over time and an investor pays a tax of 20%, after indexation, on long-term capital gains, if held for three years or more,” says Deepak Jasani, Head Retail Research, HDFC securities Ltd.

 

An investor in G-Secs or Gilt funds will have to be aware of downside risks. Interest rates and G-Sec prices have an inverse relation. Hence, if interest rates continue to rise, investors in these could witness a temporary loss in value. Further, liquidity may be limited if the investor wants to exit earlier. However, recent measures by the Government imply that this situation may improve over time.

 

A safe haven for investors with many additional advantages reflect the emergence of G-Secs as a favorable investment option.