Government Securities Market in India – A Primer

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 What is a Bond?

A bond is a debt instrument in which an investor loans money to an entity (typically corporate or government) which borrows the funds for a defined period of time at a variable or fixed interest rate. Bonds are used by companies, municipalities, states and sovereign governments to raise money to finance a variety of projects and activities. Owners of bonds are debt holders, or creditors, of the issuer.

What is a Government Security (G-Sec)?

 A Government Security (G-Sec) is a tradeable instrument issued by the Central Government or the State Governments. It acknowledges the Government’s debt obligation. Such securities are short term (usually called treasury bills, with original maturities of less than one year) or long term (usually called Government bonds or dated securities with original maturity of one year or more). In India, the Central Government issues both, treasury bills and bonds or dated securities while the State Governments issue only bonds or dated securities, which are called the State Development Loans (SDLs). G-Secs carry practically no risk of default and, hence, are called risk-free gilt-edged instruments.

Treasury Bills (T-bills)

Treasury bills or T-bills, which are money market instruments, are short term debt instruments issued by the Government of India and are presently issued in three tenors, namely, 91 day, 182 day and 364 day. Treasury bills are zero coupon securities and pay no interest. They are issued at a discount and redeemed at the face value at maturity. For example, a 91 day Treasury bill of ₹100/- (face value) may be issued at say ₹ 98.20, that is, at a discount of say, ₹1.80 and would be redeemed at the face value of ₹100/-. The return to the investors is the difference between the maturity value or the face value (that is ₹100) and the issue price 

Cash Management Bills (CMBs)

 In 2010, Government of India, in consultation with RBI introduced a new short-term instrument, known as Cash Management Bills (CMBs), to meet the temporary mismatches in the cash flow of the Government of India. The CMBs have the generic character of T-bills but are issued for maturities less than 91 days.

Dated G-Secs

 Dated G-Secs are securities which carry a fixed or floating coupon (interest rate) which is paid on the face value, on half-yearly basis. Generally, the tenor of dated securities ranges from 5 years to 40 years.

The nomenclature of a typical dated fixed coupon G-Sec contains the following features – coupon, name of the issuer, maturity year. For example, 7.49% GS 2017 would mean:

In case, there are two securities with the same coupon and are maturing in the same year, then one of the securities will have the month attached as suffix in the nomenclature. eg. 6.05% GS 2019 FEB, would mean that G-Sec having coupon 6.05% that mature in February 2019 along with the other similar security having the same coupon. In this case, there is another paper viz. 6.05%GS2019 which bears same coupon rate and is also maturing in 2019 but in the month of June. Each security is assigned a unique number called ISIN (International Security Identification Number) at the time of issuance itself to avoid any misunderstanding among the traders.

If the coupon payment date falls on a Sunday or any other holiday, the coupon payment is made on the next working day. However, if the maturity date falls on a Sunday or a holiday, the redemption proceeds are paid on the previous working day.

 Instruments:

1. Fixed Rate Bonds – These are bonds on which the coupon rate is fixed for the entire life (i.e. till maturity) of the bond. Most Government bonds in India are issued as fixed rate bonds.

   For example – 8.24%GS2018 was issued on April 22, 2008 for a tenor of 10 years maturing on April 22, 2018. Coupon on this security will be paid half-yearly at 4.12% (half yearly payment being half of the annual coupon of 8.24%) of the face value on October 22 and April 22 of each year.

2. Floating Rate Bonds (FRB) – FRBs are securities which do not have a fixed coupon rate. The coupon is re-set at pre-announced intervals (say, every six months or one year) by adding a spread over a base rate. FRBs were first issued in September 1995 in India. For example, a FRB was issued on December 21, 2009 for a tenor of 11 years, thus maturing onDecember 21, 2020. The base rate on the bond for the coupon payments was fixed at 3.79% being the weighted average rate of implicit yield on 182-day Treasury Bills during the preceding three auctions. In the bond auction coupon for the first six months was fixed at 4.8557%
3. Zero Coupon Bonds – Zero coupon bonds are bonds with no coupon payments. However, like T- Bills, they are issued at a discount and redeemed at face value. The Government of India had issued such securities in the nineties, It has not issued zero coupon bonds after that.
4. Capital Indexed Bonds – These are bonds, the principal of which is linked to an accepted index of inflation with a view to protecting the Principal amount of the investors from inflation. A 5 year capital indexed bond, was first issued in December 1997 which matured in 2002.
5. Inflation Indexed Bonds (IIBs) – IIBs are bonds wherein both coupon flows and Principal amounts are protected against inflation. The inflation index used in IIBs may be Whole Sale Price Index (WPI) or Consumer Price Index (CPI). Globally, IIBs were first issued in 1981 in UK. In India, Government of India through RBI issued IIBs (linked to WPI) in June 2013. Since then, they were issued on monthly basis (on last Tuesday of each month) till December 2013. Based on the success of these IIBs, Government of India in consultation with RBI issued the IIBs (CPI based) exclusively for the retail customers in December 2013. Further details on IIBs are available on RBI website under FAQs.
6. Bonds with Call/ Put Options – Bonds can also be issued with features of optionality wherein the issuer can have the option to buy-back (call option) or the investor can have the option to sell the bond (put option) to the issuer during the currency of the bond. It may be noted that such bond may have put only or call only or both options. The first G-Sec with both call and put option viz. 6.72%GS2012 was issued on July 18, 2002 for a maturity of 10 years maturing on July 18, 2012. The optionality on the bond could be exercised after completion of five years tenure from the date of issuance on any coupon date falling thereafter. The Government has the right to buy-back the bond (call option) at par value (equal to the face value) while the investor has the right to sell the bond (put option) to the Government at par value on any of the half-yearly coupon dates starting from July 18, 2007.
7. Special Securities – Under the market borrowing programme, the Government of India also issues, from time to time, special securities to entities like Oil Marketing Companies, Fertilizer Companies, the Food Corporation of India, etc. (popularly called oil bonds, fertiliser bonds and food bonds respectively) as compensation to these companies in lieu of cash subsidies. These securities are usually long dated securities and carry marginally higher coupon (spread of about 20-25 bps) over the yield of the dated securities of comparable maturity. These securities are, however, not eligible SLR securities but are eligible as collateral for market repo transactions. The beneficiary entities may divest these securities in the secondary market to banks, insurance companies / Primary Dealers, etc., for raising funds.
8. STRIPS – Separate Trading of Registered Interest and Principal of Securities.- STRIPS are the securities created by way of separating the cash flows associated with a regular G-Sec i.e. each semi-annual coupon payment and the final principal payment to be received from the issuer, into separate securities. They are essentially Zero Coupon Bonds (ZCBs). However, they are created out of existing securities only and unlike other securities, are not issued through auctions. Securities represent future cash flows (periodic interest and principal repayment) of an underlying coupon bearing bond. Being G-Secs, STRIPS are eligible for SLR. In India, currently dated securities (other than FRBs, IIBs and special securities) having their coupon due on Jan 2 and Jul 2 are eligible for STRIPPING. Guidelines for stripping and reconstitution of G-Secs have already been issued (IDMD circular dated March 25, 2010). For example, when ₹100 of the 8.24%GS2018 is stripped, each cash flow of coupon (₹ 4.12 each half year) will become a coupon STRIP and the principal payment (₹100 at maturity) will become a principal STRIP. These cash flows are traded separately as independent securities in the secondary market. STRIPS in G-Secs ensure availability of sovereign zero coupon bonds, which facilitate the development of a market determined zero coupon yield curve (ZCYC). STRIPS also provide institutional investors with an additional instrument for their asset liability management (ALM). Further, as STRIPS have zero reinvestment risk, being zero coupon bonds, they can be attractive to retail/non-institutional investors. The process of stripping/ reconstitution of G-Secs is carried out at RBI, Public Debt Office (PDO) in the CBS package of RBI i.e. E-Kuber through any of the Primary Dealer at the option of the holder at any time from the date of issuance of a G-Sec till its maturity. Physical securities are not eligible for stripping/reconstitution. Minimum amount of securities that needs to be submitted for stripping/reconstitution is ₹ 1 crore (Face Value) and in multiples thereof. They are currently tradable in both OTC market and on NDS-OM.
9. Sovereign Gold Bond (SGB) : SGBs are unique instruments, prices of which are linked to commodity price viz Gold. SGBs are denominated in multiples of gram(s) of gold with a basic unit of 1 gram. The tenor of the SGB is for a period of 8 years with exit option from 5th year to be exercised on the interest payment dates. SGBs are restricted for sale to resident Indian entities including individuals, HUFs, trusts, Universities, charitable institutions. Price of bond at the time of issue is fixed in Indian Rupees on the basis of the previous week’s (Monday–Friday) simple average of closing price of gold of 999 purity published by the India Bullion and Jewellers Association Ltd. (IBJA). The redemption price will be in Indian Rupees based on previous week’s (Monday-Friday) simple average of closing price of gold of 999 purity published by IBJA. The investors are compensated at a fixed rate annum payable semi-annually on the initial value of investment. SGBs are eligible for SLR, can be used as collateral for loans and are tradeable on stock exchanges.

State Development Loans (SDLs)

State Governments also raise loans from the market which are called SDLs. SDLs are dated securities issued through normal auction similar to the auctions conducted for dated securities issued by the Central Government . Interest is serviced at half-yearly intervals and the principal is repaid on the maturity date. Like dated securities issued by the Central Government, SDLs issued by the State Governments also qualify for SLR. They are also eligible as collaterals for borrowing through market repo as well as borrowing by eligible entities from the RBI under the Liquidity Adjustment Facility (LAF). State Governments have also issued special securities under “Ujjwal Discom Assurance Yojna (UDAY) Scheme for Operational and Financial Turnaround of Power Distribution Companies (DISCOMs)” 

Why should one invest in G-Secs?

Holding of cash in excess of the day-to-day needs (idle funds) does not give any return. Investment in gold has attendant problems in regard to appraising its purity, valuation, safe custody, etc. Investing in G-Secs has the following advantages:

• Besides providing a return in the form of coupons (interest), G-Secs offer the maximum safety as they carry the Sovereign’s commitment for payment of interest and repayment of principal.
• They can be held in book entry, i.e., dematerialized/ scripless form, thus, obviating the need for safekeeping.
• G-Secs are available in a wide range of maturities from 91 days to as long as 40 years to suit the duration of varied liability structure of various institutions.
• G-Secs can be sold easily in the secondary market to meet cash requirements.
• G-Secs can also be used as collateral to borrow funds in the repo market.
• Securities such as State Development Loans (SDLs) and Special Securities (Oil bonds, UDAY bonds etc) provide attractive yields.
• The settlement system for trading in G-Secs, which is based on Delivery versus Payment (DvP), is a very simple, safe and efficient system of settlement. The DvP mechanism ensures transfer of securities by the seller of securities simultaneously with transfer of funds from the buyer of the securities, thereby mitigating the settlement risk.
• G-Sec prices are readily available due to a liquid and active secondary market and a transparent price dissemination mechanism.

• Besides banks, insurance companies and other large investors, smaller investors like Co-operative banks, Regional Rural Banks, Provident Funds are also required to hold G-Secs