Context:
The yield on the benchmark 10-year government security (G-sec) in India has experienced a decline, prompting retail investors to reassess their investment strategies.
- Although the Reserve Bank of India (RBI) has allowed retail investors to participate in the government securities market, their involvement has been comparatively limited.
Relevance:
GS III: Indian Economy
Dimensions of the Article:
- Factors Influencing the Decline in G-sec Yield
- Reasons for Low Participation of Retail Investors in G-Secs
- Government Securities (G-Secs)
Factors Influencing the Decline in G-sec Yield
The yield on the benchmark 10-year government security (G-sec) has experienced a decline, with various factors contributing to this trend.
Changes in Debt Mutual Fund Taxation:
- The yield decline can be attributed to changes in debt mutual fund taxation.
- The removal of the benefit of indexation in the calculation of long-term capital gains on debt mutual funds has played a role in this decline.
- These changes have impacted investor sentiment and affected the demand for government securities.
RBI’s Repo Rate Decision:
- The Reserve Bank of India’s (RBI) decision on the repo rate has also influenced the movement of G-sec yields.
- Changes in the repo rate, which is the rate at which the RBI lends to commercial banks, can impact the overall interest rate environment.
- The RBI’s decisions regarding the repo rate can affect the demand and pricing of government securities, leading to changes in their yields.
Declining Inflation:
- Another factor contributing to the decline in G-sec yields is the trend of declining inflation.
- Lower inflation rates reduce the expectation of future interest rate hikes, resulting in lower yields on government securities.
- Declining inflation can impact the market perception of inflationary risks, affecting investor demand for G-secs.
Current G-sec Yield Levels:
- As of May 2023, the G-sec yield stands at around 6.9% after experiencing a decline from 7.4% in early March 2023.
- Presently, G-secs are trading at approximately 6.96-6.99%.
- The yield levels are reflective of the aforementioned factors and market dynamics, influencing investor decisions in the government securities market.
Reasons for Low Participation of Retail Investors in G-Secs
Complicated Investment Process:
- Retail investors often find it challenging to invest in government bonds and require guidance, potentially through intermediaries, to navigate the complex investment process.
- The intricacies of investing in G-secs can deter retail investors who prefer more simplified investment options.
Lack of Liquidity:
- The G-Sec market suffers from a lack of liquidity, making it difficult for retail investors to find buyers in the secondary market when they want to sell their securities.
- This lack of liquidity can result in investors being stuck with their investments, reducing their willingness to participate.
Daunting Investment Process:
- Retail investors, particularly those who are uninformed, may find the investment process in G-Secs daunting.
- This may lead them to prefer more straightforward investment options, such as fixed deposits, that do not require as much knowledge or expertise.
RBI Retail Direct Platform Limitations:
- The RBI Retail Direct platform, while beneficial for informed investors, may not cater to uninformed participants who require a simpler investment process.
- This limitation can hinder retail investor participation in the G-Sec market.
Low Traded Volume:
- The traded volume in the secondary market for G-Secs has been relatively low.
- This further reduces the attractiveness of G-Secs for retail investors, as it may limit their ability to enter or exit positions in a timely manner.
Alternative Investment Avenues:
- Retail investors may consider alternative investment avenues, such as fixed deposits, that have seen increased interest rates.
- Exploring new bonds, NCDs (Non-Convertible Debentures), and post office deposit schemes could also divert retail investor attention away from G-Secs.
Government Securities (G-Secs)
Government Securities, often referred to as G-Secs, are tradable instruments issued by the Central Government or State Governments to borrow money from the public and finance their fiscal deficit. They are a type of debt instrument.
Debt Instrument:
- A debt instrument represents a contractual obligation by the issuer (government) to pay the holder a fixed amount of money, known as the principal or face value, on a specified date.
- G-Secs acknowledge the government’s debt obligation and serve as a means for the government to borrow funds.
Short-Term and Long-Term:
- G-Secs can be categorized as short-term or long-term securities.
- Short-term securities, known as treasury bills, have original maturities of less than one year, commonly issued in tenors of 91 days, 182 days, and 364 days.
- Long-term securities, called government bonds or dated securities, have original maturities of one year or more.
Central and State Government Issuance:
- The Central Government in India issues both treasury bills and bonds or dated securities.
- State Governments, on the other hand, issue bonds or dated securities known as State Development Loans (SDLs).
Risk Profile:
- G-Secs are considered risk-free gilt-edged instruments, meaning they carry minimal risk of default.
- These securities are considered safe investments due to the backing of the government.
Gilt-Edged Securities:
- Gilt-edged securities are high-grade investment bonds offered by governments and large corporations to borrow funds.
- G-Secs fall under this category as they are considered secure investments.
Role of RBI:
- The Reserve Bank of India (RBI) conducts Open Market Operations (OMOs) involving the sale or purchase of G-Secs to adjust money supply conditions.
- The RBI sells G-Secs to remove liquidity from the system and buys them back to infuse liquidity.
Bond Yield:
- Bond yield refers to the return an investor realizes on a bond.
- The yield is calculated by dividing the annual coupon rate (interest paid by bond issuers on the bond’s face value) by the current market price of the bond.
- Bond prices and yields have an inverse relationship: when bond prices rise, yields fall, and vice versa.
Bonds:
- A bond is an instrument used to borrow money, which can be issued by a government or a company to raise funds.
- G-Secs are a type of bond issued by the government to raise funds.
Coupon Rate:
- The coupon rate represents the interest rate paid by bond issuers on the bond’s face value.
Types of Government Securities (G-Secs)
Treasury Bills (T-bills):
- Treasury bills are short-term government securities with maturities of less than one year (commonly 91 days, 182 days, and 364 days).
- T-bills are issued at a discount to their face value and do not pay any interest. Instead, they are redeemed at the face value upon maturity.
Cash Management Bills (CMBs):
- CMBs were introduced by the Government of India in 2010 to address temporary cash flow mismatches.
- Similar to T-bills, CMBs are short-term instruments with maturities of less than 91 days.
- They serve the purpose of meeting the immediate funding requirements of the government.
Dated G-Secs:
- Dated G-Secs are long-term government securities that carry a fixed or floating coupon (interest rate).
- These securities pay interest on the face value on a half-yearly basis.
- The maturity period of dated G-Secs typically ranges from 5 years to 40 years, providing investors with long-term investment options.
State Development Loans (SDLs):
- State Governments also raise funds from the market by issuing securities known as State Development Loans (SDLs).
- SDLs are similar to dated G-Secs and are issued through auctions conducted by the state governments.
- These securities help state governments finance their developmental and expenditure requirements.
-Source: Indian Express
