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Are Government Bonds better option to Fixed Deposits?

, November 30, 2017, 0 Comments

The prime objective of Fixed Income investors is to have stable income on their investments with Capital protection. The general risk appetite of the fixed income investors are considered to be low or rather they are considered to be risk averse.

In India Debt investment has primarily been limited to Fixed Deposit, PPF, NSC, and Fixed Income plans of Mutual Funds.

Mutual Funds by and large had attracted Institutional Investment in debt segment in a big way and had made repeated attempt to attract Fixed deposit investors too by offering variety of products from Ultra short term plans to Duration Funds. Though Fixed Maturity Plans (more commonly known as FMP’s) attracted good money, tweak in Taxation witnessed abrupt halt to the growing interest of Fixed Income Investors.

Fixed deposit with Scheduled Commercial Banks remained most sought after investment option for Fixed Income investors of all class due to its simple structure and had protected both Capital and Interest (Return) on the expected line without much deviation(Risk). Fixed Deposit as an instrument is a loan given by the investor(Lender) to a Bank (Borrower) for a fixed time period on a predetermined fixed interest rate.

When the lender lends money to the Bank as an investor it takes risk on the credit worthiness (ability to repay the Principal and interest) of the respective Banks. Credit rating agencies like CRISIL, CARE, ICRA do assign specific ratings to specific borrowing of these Banks. Banks with higher credit rating offer lesser interest rate to its investor vis a vis Banks with lower credit rating as is evident from the table below:government-bonds-fixed-deposits-interest-rates-marketexpress-in

The cost of Borrowing for the higher rated Bank (in this case SBI) is less than the cost of borrowing for a lower rated bank (OBC in this case) i.e from investors perspective SBI will offer a lower rate of interest compared to OBC to its Fixed deposit investors with similar maturity. Credit rating plays a very important role in the profile of a borrower while determining its cost of funds.

An investor always trades off the risk reward matrix while lending its money. The objective shall be to “maximize the return while optimizing the risk” at the same time. A fixed Income investor can practice the above principle by lending with minimum or zero default risk and earning maximum at the same time.

Which instrument in the domestic economy or financial market has zero default risk? The answer to this is “Government Bonds” are the Fixed Income instrument with zero default risk. An individual can lend to the Government of India for a fixed period of time and can earn interest on it.

What? Government of India borrows money from the market and that too will borrow from individuals……?

Yes, to bridge the gap between its revenue and receipts (read as Earning and Expenditure respectively) Government of India Borrows money from the domestic market and pays its lenders interest on it. All Indian nationals are eligible to buy Government Bonds. In the current FY the Gross borrowing of the Government of India will be INR 5,80,000 crores.

Government Bonds may prove to be an interesting investment option vis a vis Fixed Deposit as it has all the attributes what a fixed income investor desires for viz safety, stability, flexibility, liquidity and tradability. It has the basic soul of any fixed income instrument to deliver the expected return over a fixed period of time and also has the option of MTM fluctuation like an equity instrument. If we compare GOI Bonds and Fixed Deposit of State Bank of India:government-bonds-fixed-deposits-marketexpress-in

If we compare the above features GOI Bonds scores primarily for its zero default risk and as an instrument which can be tradable in the market making it more liquid. We may remember the fact that in case of any Bank failure, Deposit Insurance and Credit Guarantee (DICGC) insurance cover for an investor in Fixed Deposit with a single Bank is covered upto Rs.1, 00,000 inclusive of both Principal and Interest amounts held by him. There is no such limited or partial guarantee in GOI Bonds, every penny of  the lender’s money is the liability and responsibility of the Government of India itself. Unlike NSC and PPF there is no cap on amount of maximum investment. An individual can invest a minimum of INR 10,000 and in multiples of that.

The current interest rate scenario has thrown a rare opportunity to FD investors, as in Commercial Banks are reducing interest rates on respective FDs, Government Bonds are witnessing a rise in its yield. A lower rated instrument is offering less return to its investor whereas an instrument with zero default risk and the highest credit rating is offering better return. This is an anomaly which may be flash a signal towards realignment of interest rate in the economy and hence normality may get restored sooner than later.government-bonds-fixed-deposits-maturity-marketexpress-in

On January 16, 2003 Retail Debt Market segment was launched at NSE to encourage wider participation of retail investors in the Debt Market segment. More than a decade has passed, but the participation has remained negligible. Primary Dealers like I-SEC, PNB Gilts, STCI, SBI DFHI are market makers of Government Bonds and provide both Buy and Sell rate for specific Government Bonds on a daily basis. IDBI Bank launched a portal to facilitate buying and selling of Government Bonds for retail investors. Axis Bank has also taken initiatives in the retailing of Government Bonds.

Diversification of investment assets is what the basic principle of investments is, and diversification within the asset class leads to a robust and developed financial market. By this investors shall have bouquets of investment options, instruments and opportunities to choose from. Scenario of higher interest rate on Government Bonds vis a vis Banks may not exist for long, but the safety of zero default risk and tradability shall always charm the investment acumen of Fixed Income retail investors.