List of Top 5 Government Bonds to Invest in India!
1. Central Government Bonds:
If you spend more than you earn, how do you sustain? You will borrow. This is precisely the purpose of Bonds issued by the Central Government. Before the beginning of every financial year, the Central Government announces its Financial Budget- Its anticipated expenditures and sources of revenue.
To the extent this revenue falls short of the expenditure, the government borrows money by issuing Bonds. These bonds have maturities ranging from more than one year to about thirty years. Since their maturity dates are specified in advance, these bonds are also known as Dated Securities.
These securities usually have fixed rate coupons (although some floating rate coupons too have been issued) and pay interest semi-annually. These dated securities are issued by an auction process and the securities can be held electronically i.e. in demat mode. The minimum investment in these securities is Rs. 10,000 and in multiples of Rs. 10,000 thereafter.
The dated securities are issued by the Reserve Bank of India (RBI) on behalf of the Government through auction process. The RBI releases a semiannual auction calendar specifying the quantum to be borrowed, the auction dates and the terms of the securities to be issued. The Public Debt Office (PDO) of the RBI manages this auction and also facilitates servicing of the debt i.e. payment of periodic interest and repayment at maturity.
These securities are perceived to be free of risk of default since they have sovereign credit profile. These securities are the most highly traded and therefore liquid in the secondary market.
2. State Government Bonds:
The State Governments also issue bonds for exactly the same reason as the Central Government does to fund its deficit. These bonds are also known as State Development Loans. They are issued by an auction process and usually have a maturity of around ten years. The issuance and servicing of these bonds too is managed by the RBI. The minimum investment in these Bonds is Rs. 10,000 and in multiples of Rs. 10,000 thereafter.
Although these securities are not specifically guaranteed by the Central Government, they are considered virtually default risk-free.
3. Treasury Bills:
Treasury Bills (T Bills) are short term instruments issued by the Central Government with maturities less than one year. Their purpose remains the same as Dated Securities, but they are intended more to meeting the short term funding needs of the Central Government. Currently, the Central Government issues T Bills of 91 -day, 182-day and 364-day maturity. Since T Bills have a maturity of less than one year, they are considered to be a money market instrument.
As opposed to dated securities, T Bills do not carry any interest. Instead, they are issued at a discount to their face value and redeemed at face value. Such a security is known as a Zero Coupon Security.
Like dated securities, the T Bills are also issued by an auction process which is managed by the RBI. The RBI announces its auction calendar for T Bills usually on a quarterly basis. The auction calendar specifies the date of the auction, the tenure of the T Bills and their face value. Thus the 91-day, 182-day and 364-day treasury bills are commonly referred to as the Auction Treasury Bills (ATBs).
Although the 14 days T-Bills are discontinued, they are still in use in a special way. Unlike the auctioned T-Bills the 14-day T-Bills are referred to as Intermediate Treasury Bills (ITBs) and the surplus cash balances of the state governments are automatically invested in these 14-day intermediate T Bills which earn the states a yield of 5%. These Bills can also be rediscounted by the states at a penal interest of 0.5%.
The T-Bills too are perceived to be free of default risk since they have a sovereign status. Further, they are highly liquid i.e. they can be sold without much delay.
4. Cash Management Bills:
Cash Management Bills (CMB) are a short term instrument issued by the Government of India and are meant to specifically meet temporary cash flow mismatches of the Government.
These instruments have a maturity of less than 91 days. Further, they are non-standardized instruments and are issued at a discount to par value (in the nature of zero coupon securities).
The CMBs have a generic character of Treasury Bills.
Some of the key features of these bills are as follows:
I. The tenure, notified amount and date of issue of Cash Management Bills depend upon temporary cash requirement of the Government (subject to a maximum tenure of 91 days)
II. The CMBs are issued at discount to the face value through auctions, as in the case of the Treasury Bills
III. The announcement of auction of CMBs is made by the Reserve Bank of India through separate press releases issued one day prior to the date of auction.
IV. The settlement of the auction is on T+1 basis
V. The Non-Competitive Bidding Scheme for Treasury Bills is not extended to the CMBs
VI. The CMBs are tradable and qualify for ready forward facility (underlying for repo)
VII. Investment in Cash Management Bills is treated as an eligible investment in Government Securities by banks for SLR purpose.
5. Municipal Bonds:
This category comprises of funds raised from capital markets by local administrations or statutory undertakings providing civic and infrastructure services. These bonds are most commonly used to finance large infrastructure projects like toll roads, bridges, dams, et cetera.
Since these public assets generate a more or less stable cash flow over a very long period, the bonds issued to finance these assets are usually long term. An attractive feature of these bonds is that they are generally issued as tax-free.
Municipal Bonds have played a significant role in the development of infrastructure assets in several countries, especially the United States and Canada.
Generally, these bonds can be of two types:
i. General Obligation Bonds:
These Bonds are typically secured by some form of tax revenue. These bonds are used for financing the general municipal functions and not any specific revenue-generating projects.
ii. Revenue Bonds:
These are bonds issued to finance specific projects and ventures. The revenue generated by the project operations are then used to repay the debt obligation.
The market for municipal bonds in India is in a very nascent stage but nevertheless shows huge potential given the anticipated spending on infrastructure in the future. It presents an opportunity for the municipal bodies to raise finance without depending on their respective State Governments. Some of the municipal corporations that have tapped the capital markets for their finances are Ahmedabad Municipal Corporation, Nagpur Municipal Corporation and Vishakhapatnam Municipal Corporation.
Corporate Debt- Public Sector Undertaking (PSU) Bonds and Private Sector Bonds:
Bonds issued by corporates are broadly classified into those issued by Public Sector Undertakings and those by Private Sector Undertakings. The reason for this classification is the perceived low risk in the case of PSU Bonds because of their sovereign holdings.
It is only a perceived risk-free security since the Government may not necessarily have a contractual obligation to guarantee PSU Debt. A private corporate, howsoever stable it may be, will still have a risk premium over a comparable Public Sector Undertaking.
Corporate Bonds, unlike Government Bonds, are issued for several different maturity periods and structures. Corporates, especially private corporates, have been coming out with several innovative and complex structures such as embedded call and put options, convertibles, floaters, et cetera.
Corporate Bonds are now actively traded in the secondary market. The most common platforms for trading of these corporate bonds are the Stock Exchanges. Moreover, trades that happen over the counter are supposed to be reported by the market participants on the FIMMDA reporting platform or the reporting platform of the NSE or BSE within the stipulated time period.
Special Securities:
The Central Government also issues, from time to time, special securities to entities like Oil Marketing Companies, Fertilizer Companies, the Food Corporation of India, etc. as compensation to these companies in lieu of cash subsidies. These securities are usually longer term securities carrying coupon with a premium over the yield of the dated securities of comparable maturity.
These securities are, however, not eligible SLR securities but are approved securities and are eligible as collateral for market repo transactions. The beneficiary oil marketing companies may divest these securities in the secondary market to banks, insurance companies / Primary Dealers, etc., for raising cash.
Securitized Debt Instruments- Single Loan and Pools; Asset Backed and Mortgage Backed:
Securitized Debt Instruments represent a fairly recent development in the world of Fixed Income Securities. In simple terms, securitization is a process by which illiquid assets are converted into liquid securities. One asset gives birth to several others.
The securitization process involves the following general steps:
a. The holder (known as Originator or Sponsor) of the assets to be securitized (called as underlying assets) creates a Special Purpose Vehicle (SPV) to hold the title to the assets.
b. The sponsor then sells the underlying assets to the SPV. The assets may be existing or potential (future)
c. The SPV then uses the underlying asset(s) as collateral to create and issue securities to investors.
d. The proceeds from the issue of securities are then used to pay off the sponsor for the sale of the underlying asset.
This whole process effectively converts illiquid assets into marketable liquid securities.
Securitized debt instruments can be broadly classified into two types, based on the nature of the underlying assets:
1. Mortgage Backed Securities:
Here mortgages on residential or commercial properties are used as underlying asset to create new instruments. Typically, a bank or financial institution providing mortgage finance will pool together its several loan assets and sell it off to an SPV. The SPV will then use this pool of assets to create and issue new securities.
2. Asset Backed Securities:
Here financial assets other than mortgage loans are used as underlying collateral to create securitized instruments.
The most common forms of assets used are:
I. Business Loans
II. Vehicle Loans
III. Student Education Loans
IV. Credit Card Debt
The underlying asset in this case may be a single asset or a pool of assets. Further, the asset may also be a potential asset as in the case of credit card debt (future credit card debts are uncertain).
Securitized Debt Instruments are a small but nevertheless burgeoning segment of the wholesale debt market. There is however an uncertainty in the regulatory environment for the securitized debt market which has been an impediment to the volume growth in this sector. Also, the financial crisis of recent times has brought out some of the perils of this asset class which has affected investor interest.
Money Market Instruments- Certificate of Deposits and Commercial Papers:
1. Certificate of Deposits (CDs):
CDs are allowed to be issued by banks and select all-India Financial Institutions as a source to meet short-term funding needs. Ideally, banks use CDs as a source of finance during a credit pick-up i.e. when incremental deposits are unable to finance incremental credit.
These are privately placed unsecured instruments in the form of promissory notes.
Banks can issue CDs of any amount depending on their requirements. However, the select Financial Institutions are allowed to issue CDs only within the umbrella limits fixed by the RBI. The minimum amount of CD issue to any single investor is Rs. one lakh and in multiples of Rs. one lakh thereafter.
CDs may be issued as zero-coupon securities or as coupon securities. The coupon is allowed to be fixed or floating. However, CDs are mostly issued as zero-coupon securities in the market. CDs can be issued to individuals as well as corporate and are transferable and tradable in the secondary market. Nonresident individuals can also invest in CDs, although on a non-repatriable basis.
CDs may be held in physical form as well as demat form. CDs in physical form are transferable by simple endorsement and delivery. Similarly, the CDs in demat form can be transferred as per the regular procedure applicable to other demat securities. There are no lock-in period restrictions for CDs. However, Banks and financial institutions are not allowed to lend against CDs. Also, a Bank/FI cannot buy back its own CD prior to maturity.
It’s important to note that while we have mention that the CDs can be held in physical form as well as demat form, the issuers, by default, are allowed to issue CDs only in dematerialized form. It is the investor who may request the issuer to issue him the certificate in physical form.
2. Commercial Papers (CPs):
CPs are issued by corporates, primary dealer and all-India financial institutions (other than Banks), as a source of short term finance.
A corporate entity is allowed to issue CP only if:
a. Its tangible net worth as per the latest audited financial statements is Rs. 4 crore or more
b. The company has been sanctioned a working capital limit by bank/s or all-India financial institution/s.
c. The company’s borrowings are classified as a ‘standard asset’ by the bank/s or the all- India financial institution.
The CP issue is required to be mandatorily rated by a recognized credit rating agency and the issue cannot be made unless it has the specified credit rating.
Further, the minimum amount of CPs that can be issued is Rs. 5 Lakh and further in multiples thereof. The maturity period of CPs can range from 7 days to one year. An important point to consider in the case of maturity period of the CPs is that the maturity date of the issue should not go beyond the date up to which the credit rating of the issuer is valid.
Credit rating also plays an important role in determining the quantum of CPs that can be issued by an issuer. As per the regulatory guidelines, the aggregate amount of CPs from an issuer entity should be-
a. Within the limits sanctioned by the entity’s board of directors or the quantum indicated by the credit rating agency for the specific rating, whichever is lower.
b. In the case of a financial institution, it should further be within the umbrella limits fixed by the RBI.
Call Money Market and Collateralized Borrowing and Lending Obligations (CBLO):
1. Call Money, Notice Money and Term Money:
Call Money, Notice Money and Term Money are the terms used for short term borrowing and lending operations between Banks and sometimes with and between Primary Dealers. The difference between the three is in their tenure of lending.
There are restrictions placed by the RBI on the amount that can be borrowed or lent by Banks and Primary Dealers in the Call and Notice Money market. Such limits are called as prudential limits by the RBI. Non-banking institutions have been gradually phased out from the Call and Notice money market. This is in fact one of the reasons for the development of the CBLO market discussed below.
Parties in Call Money, Notice Money and Term Money market are free to decide on the interest rates at which they want to strike a deal. However, the term money market unfortunately has only a theoretical existence in India.
2. Collateralized Borrowing and Lending Obligations (CBLO):
CBLO is a money market instrument that uses Government Securities as collateral to facilitate borrowing and lending on short term. The maximum tenure of a CBLO instrument is one year. It is largely used for access to money market by those entities who have no or restricted access to the inter-bank call money market.
CBLO as a product was developed by the Clearing Corporation of India Limited (CCIL). The CCIL takes a counterparty position in all CBLO trades and guarantees their settlement. The collateral security is to be deposited by the borrower with CCIL. A CBLO instrument effectively creates an obligation on the borrower to repay the amount borrowed along with interest, on a predetermined future date.
The CBLO market can be accessed by Banks, Financial Institutions, Insurance Companies, Corporates, NBFCs, et cetera by availing the CBLO membership.
The advantage of the CBLO market is that it uses an anonymous order-matching system while striking deals. This feature separates the CBLO market from other money market instruments since it functions like a market traded instrument.
The CBLO market uses ‘Yield-Time Priority’ as the matching principle when matching orders in the CBLO market. This is very similar the ‘Price-Time Priority’ principle followed in the equity markets.
Repo Market:
‘Repo’ is short for ‘Repurchase Agreement’. It is a creative and indirect way of collateralized borrowing and lending.
The basic process of a repo transaction goes like this:
a. You need funds for a short period. You have a security, say a government bond.
b. Instead of borrowing money using the Government Bond as collateral, you sell the bond to a buyer for a price and get the money you need.
c. But while you contract for sale of that security, you enter into another contract simultaneously – a contract to buy back (or ‘repurchase’) the security on a future date.
d. The repurchase price will obviously be at a little higher price than that at which you sold the security in the first place.
e. On that specified future date, you repurchase your own Government Bond at the specified higher price.
This completes the Repo Transaction. If you realized, in the steps above, you just borrowed money and repaid it too! To better understand, let’s revisit the steps above-
When you sold the Government Bond to a buyer, you actually borrowed money using the Government Bond as a kind of collateral. The buyer of this bond was the lender and the price at which you sold the Bond was the loan amount.
When you simultaneously contracted to repurchase the Bond at a future date, you actually contracted to repay your loan at that future date.
When you actually bought back the Bond at the future date, you effectively repaid your loan and got back your collateral security – that Government Bond.
The higher price that you paid to buy back your own security was the interest that you paid for borrowing the loan.
The term ‘Repo’ and ‘Reverse Repo’ are actually two sides of the same coin. If you are the borrower the transaction is Repo for you – ‘Sell- Repurchase’. If you are the lender, that same transaction is reverse Repo for you – ‘Buy-Resell’.
The repo rate is the Interest Rate inherent in the repo transaction. Repo is most commonly used for borrowing and lending overnight i.e. for one day.
Liquidity Adjustment Facility:
Liquidity Adjustment Facility (LAF) is a tool used by the RBI to manage the day today surplus or deficit in the banking system. The LAF scheme, as it stands today, was introduced in the year 2004. The repo market in India is regulated by the RBI. The RBI specifies the eligible securities that can be bought and sold in the Repo market as well as the Repo rate.
Only specified government securities are allowed to be used in a Repo transaction and the Repo Rate and the Reverse Repo Rate are pre-notified by the RBI. Moreover, the RBI acts as the counter-party in a Repo and Reverse Repo Transaction.
The features of a Repo and the fact that the RBI acts as counterparty to the transaction has important consequences. This market serves purposes greater than providing funding. The RBI uses the repo and reverse repo to manage the liquidity in the banking system.
If the liquidity in the banking system is tight, the RBI provides finance to Banks at the Repo Rate. If the liquidity in the banking system is in surplus, the RBI provides banks with a facility to park their excess funds at the reverse repo rate. The RBI will also change the Repo rates to strike a balance between economic growth and inflation.
If the RBI is worried about rising inflation, it will raise the Repo rate. This will make it costly for banks to access funds. The bank will in turn increase the rate at which it loans to corporate and the general public.
As the borrowing cost for corporate and general public increases, they will reduce their spending. As the general spending in the economy reduces, prices will fall and inflation is tamed! The opposite will be the case is the RBI wants to increase the economic growth.
The repo market also plays an important role in helping banks to meet their Statutory Liquidity Ratio (SLR) requirements. The SLR compliance is tested on a specified day on fortnightly basis. In case of shortfall, Banks use reverse repo to purchase the amount of securities that meet the shortfall, ensure SLR compliance on the specified date and resell the security later under the reverse repo terms.
Under this LAF, the RBI performs Repo and reverse-Repo auctions on a daily basis. The tenor of the Repo is 7 days while that of the reverse-Repo is overnight. The rate of the Repo and the reverse-Repo are pre specified by the RBI and are often referred to as the ‘policy rates’.
Repo in Corporate Bonds:
The RBI recently allowed repo transaction in corporate bonds which can be carried out by the specified parties. The RBI has specified a minimum rating and certain other eligibility criteria for an instrument to be used as an underlying in the corporate bond repo market. The parties allowed to participate in the corporate bond repo market are banks, financial institutions, non-banking finance companies, mutual funds, etc.