Planning to invest in Government securities? Here’s everything that you need to consider before investing.

In February this year, the Reserve Bank of India unveiled a scheme known as RBI Retail Direct Scheme and opened the gates for retail investors to directly invest in the risk-free Government Securities (G-Secs) for a fixed income. According to the scheme, a retail investor is now eligible to open and maintain a Retail Direct Gilt Account (RDG Account) with the Central bank through a portal.

Having such an account will offer the investors to have access to both primary as well as secondary market operations. The primary market includes buying of bonds and treasury bills directly from RBI and the secondary market includes buying a bond at a prevailing market price from others. 

Significant participation will support the government’s expanding borrowing plans, approximated at around Rs 12 lakh crore per annum. This scheme is most likely to challenge fixed deposit schemes of bank and post office savings. The fixed deposit interest rate of banks have been declining steadily.

The rate of interest offered to customers was around 7.25 per cent in 2011 that dropped to 7.1 per cent in 2014 and finally, 5.4 per cent in 2021. Economists believe that the era of 10-12 per cent interest rate is never going to return. In such a scenario, the RBI’s scheme to allow retail investors to directly invest in G-Secs is expected to bring a respite. 

Who are Retail Investors?

A retail investor is a non-professional investor who sells and buys securities or funds that comprise a basket of securities such as mutual funds and exchange-traded funds (ETFs). They are also known as an individual investor. 

What are Government Securities?

Government Securities or G-Secs are debt instruments that are issued by the government. They are regarded as the safest form of investment because the government will not default as it has the alternative to raise funds through taxes and other means if by chance it faces difficulties in repayment. Through this scheme, RBI has allowed retail investors to buy and sell government bonds, treasury bills, Sovereign Gold Bonds and State Development Loans.

Presently, retail investors are permitted to submit non-competitive bids in auctions of government bonds. They could access the Negotiated Dealing System-Order Matching (NDS-OM) through stock exchanges that would combine the demand for gilts and present it to RBI in NDS-OM. With the new scheme setting in, retail investors can now open a gilt account with the RBI and set a direct bid on NDS-OM as well as trade in the secondary market.

Until now, only institutional contenders like banks, insurance companies, primary dealers, mutual funds, high net worth individuals and foreign portfolio investors had direct entry to this platform. Normally, gilts are traded on NDS-OM in sets of Rs 5 crore each. Now, retail investors have been permitted to trade with a minimum investment of Rs 10,000.

How will the RBI’s new scheme work?

To avail of the scheme, an investor must satisfy few essential requirements. For retail investors to register online, they must possess a rupee savings bank account in the country, a Permanent Account Number (PAN) and a valid KYC document. Retail investors who are residing outside India are eligible to invest in government securities under the Foreign Exchange Management Act, 1999. An RDG account is opened jointly or singly.

Investors are required to fill up an online form. As soon as their RDG account is opened and functional, the details for operating the portal will be sent through SMS or E-Mail. No fee is chargeable for opening/operating the account or placing bids.

For participation in the primary market, the RBI has permitted only one bid per security. Payment can be done through net banking or UPI. At the time of submission of bids, if UPI is used as the mode of payment, funds in the linked account can be blocked and the amount will be debited on the allotment in the auction. In due course of time, it is expected that a similar facility will be made available through banks.

Assigned securities will be issued by credit to the investor’s RDG Account at the time of settlement. Whereas, refunds will be credited to the investor’s bank account. 

In the case of secondary market trades, registered retail investors can operate a transaction link on the portal to buy or sell gilts. Securities that an investor bought will be credited to the RDG Account at the time of settlement. The RBI will announce the date of the launch of the scheme.

How is it profitable for the investors?

G-Secs offers investors a variety of debt investment options. Through investing in G-Secs, investors not only have an interest income but can also make capital gains by trading in gilts, depending on the course of interest rates. If an investor possesses a bond carrying a yield of 6 per cent, an increase in yield will decrease the price of the bond. So, if the investor wants to trade the bond before it attains maturity, the increase in yield will result in capital loss. Similarly, a decrease in yield below 6 per cent would benefit the investor as the price of the bond will increase.

On top of that, investors who are saving for retirement are exposed to low reinvestment risks. In comparison to Fixed Deposits that are available for a maximum time of 10 years and hence the investor face a reinvestment risk, an investor in G-Secs can lock himself at the current yield for 20-30 years.

What are risk factors in investing directly?

Before investing, one should keep in mind that G-Secs are considered volatile. According to experts, investors who understand these instruments or are ready to hold them till maturity should consider them. Many believe that although G-Secs are safe and risk-free assets, it is convenient to invest through mutual fund schemes than the former. For investors who are ready to wait till maturity and are not tensed by volatility, one of the benefits of investing directly is that they will save a considerable amount on the expense ratio charged by mutual funds.

G-Secs are exposed to tax on bot interest income and capital gains if papers are exchanged in the market before maturity. Interest income is taxed at the marginal tax rate whereas capital gains are taxed at 10 per cent. If the papers are held till maturity, G-Secs are exempted from capital gains tax.

Things to keep in mind before investing directly in G-Secs

G-Secs yields are dependent on several factors and the investors must keep a track of both global and domestic developments. In the market, experienced investors believe that fixed-income investors sail and sink depending on the rise and fall of interest rates. Investors make hefty capital profits when the interest rate sinks and suffer considerable losses when the interest rate climbs up steadily. Such risks are excluded when the gilts are held till maturity. 

Whereas interest rates and inflation are affected by several other components such as money supply, economic growth, government borrowing, sovereign rating, global liquidity and geopolitical developments. It is advised to the investors to be aware of such factors before investing in any instrument.