Should you buy govt. bonds?

Tue, 11 Jun Pre-Open

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In India, the Central Government issues various types of (long term and short term) securities in order to raise funds. This is largely done to finance its fiscal deficit. Government securities (G-Secs) carry practically no risk of default and, hence, are called risk-free gilt-edged instruments. G-Secs acknowledge Government's debt obligation.

In layman's language, G-Secs can be referred to as certificates issued by Government of India (GOI) through the Reserve Bank of India (RBI), acknowledging receipt of money in the form of debt. These instruments bear a fixed interest rate payable semi-annually. The term, G-Secs include government-dated securities (central government securities), state government securities and treasury bills.

Interest rates and price of G-Sec are inversely related. This means that if interest rates rise, price of the bond falls. Conversely, if interest rates fall, the price of the bond rises. Currently India is witnessing increasing pressure of rising inflation and widening fiscal deficit. As per an article in business standard, G-Secs are witnessing good traction since last one month on back of cut in interest rates.

Historically, major participants in the G-Sec market have been large institutional investors. So, LIC has been one of the major investor in the G-Sec. However, over time, various measures have been developed to widen the investor base of these government securities. The market has witnessed the entry of smaller entities such as co-operative banks, small pension funds and other funds etc. These entities are mandated to invest in Government securities through respective regulations. But now even retail investors are encouraged to invest in G-Secs and hence various options have been put forward by the GOI for retail investors to invest in the G-Secs.

So should investors invest in G-Secs? One should note that though G-Secs are considered as the safest investments but actually there are several risks associated to it. Some important risks highlighted in business standard are:-

• The ticket size for retail investors is usually smaller, and thus they have to negotiate with banks. Hence, when investors buy or sell they often end up paying more by 10-15 paisa on a single bond. In short, the trading costs are high.

• While there is no minimum amount stipulated by the GOI, most of the banks do not agree to open accounts unless one wants to invest at least Rs 1 lakh. Thus, an investor should have enough funds making investments.

While G Secs are free from credit risk it may be noted that that there are quite a few constraints that individual investors face while investing in them. Also, it may be noted that various financial institutions have to mandatorily put some money in G-Secs. Thus, if an investor is already holding stake in such financial institutions they are already exposed to risks of G-Secs and thus should also consider the same while taking future investment decisions. In addition, to this if the interest rate on the G-Secs is lower than the prevailing inflation rate then you lose out as your purchasing power goes down since these bonds are not inflation indexed. Therefore, investors would do well to keep these points in mind and do their homework before investing in such bonds.