The hitherto inaccessible government securities market has become an avenue for savers in India. The Reserve Bank of India's Retail Direct Platform is the game changer. Platforms from other financial technology players, too, are an avenue for investing in low-risk government bonds.

In the last two decades, the government bond market has become the largest segment in the fixed-income market in India. But retail participation has been thin. Only banks, mutual funds, insurance companies, and foreign investors have been active.

With the launch of Retail Direct Access, the RBI has been hoping that the investor base will widen with retail investors participating in government bonds, which have zero credit risk.

A retail investor can open and maintain a 'Retail Direct Gilt Account' (RDG Account) with the RBI and can submit non-competitive bids in the primary market and can also trade in the secondary market through the Negotiated Dealing Order Matching System (NDS-OM).

As per the RBI data, there were a total of 114 outstanding government securities (excluding special securities) amounting to ₹90.74 trillion on Feb 6, 2023.

What Exactly Are Government Bonds?

The government of India requires funds to meet its planned and unplanned expenditures. One of the main sources of government funding is the debt capital market.

A debt instrument issued by the government is called a government bond. They are also known as sovereign debt, gilts, gilt-edged bonds, and G-sec (government securities). In other words, government bonds are issued by the government of a country and sold to institutional and non-institutional investors to support government spending.

The G-sec may offer regular coupon or interest rate payments and is generally considered a risk-free instrument as the government can print the currency to repay its debt obligations. However, G-sec offers lower interest rates as there is little, or no risk compared to other entities and corporates on their debt instruments.

These bonds have varying maturities, with short-term maturities ranging from Treasury bills to 40-year bonds.

In India, the RBI (central bank) borrows, repays, and manages funds raised through government securities on behalf of the government. The government issues debt through the RBI's "auction mechanism" in the primary market, and the secondary market provides an exit or trading route for these securities.

Types of Government Securities

Central government borrowing can be used to either fund a temporary liquidity shortfall or fund long-term asset creation. The government issues both short-term debt papers that mature within a year and bonds with a tenor between 1 year and 40 years.

T-bills: The treasury bills, or T-bills, are issued at a discount to their face value and are redeemed at their par value at the time of maturity. T-bills do not offer any interest or coupon payment and are referred to as an example of "zero-coupon" securities. The RBI sells 91-day, 182-day, and 364-day T-bills on behalf of the Government of India through auctions. These T-bills auctions are conducted weekly on Wednesdays.

Cash Management Bills (CMBs): To meet the temporary liquidity mismatch in the cash flow of the government, the government issues CMBs with a maturity of up to 91 days. It is also issued to absorb excess liquidity in the system. The RBI has been using CMBs to effectively manage short-term liquidity issues such as increased foreign investor inflows.

Fixed-rate Bonds: The largest component of government bond issuance is done through fixed coupon-paying securities in India. The coupon payments for these securities are made on a semi-annual basis. The RBI conducts auctions for various maturities of government bonds on Fridays. Retail participants are allowed to purchase up to 5% of the total notified amount through a non-competitive bidding process auction in the primary market via the RBI Retail Direct platform or intermediaries.

Inflation-indexed bonds (IIBs): As the name suggests, these bonds are linked to inflation in the economy. These IIBs protect both the principal amount and coupon payments against inflation. The first IIBs were issued by the Government of India in Jun 2013, linked to the wholesale price index (WPI). The government also issued IIBs linked to the consumer price index (CPI) in Dec 2013 for retail investors.

State governments also issue bonds known as "state development loans" (SDLs). These SDLs are also considered government bonds.

There are various other debt instruments that the government has issued so far, such as floating rate bonds, zero coupon bonds, embedded put/call option bonds, food bonds, oil bonds, and sovereign gold bonds, among others.

Benefits of Government Bond market

There are several benefits for both the government and investors in a well-developed government debt market. Debt markets enable the raising of funds at lower borrowing costs or at reasonable rates to support the economy's development and growth.

These bonds are highly liquid in the secondary market and provide greater price efficiency for the government's future borrowing needs. The sovereign yield curve based on the G-sec helps in the pricing of various financial products, and schemes and is also an indirect channel for monetary policy transmission besides meeting the government's funding plan and needs.

It also provides information on the price discovery process through credit risk appetite, spread, default probability, etc. Investors gain from a steady income, and government securities are considered low-risk investments or a safe haven for investments.

A well-functioning government debt market also helps in deriving the benchmark sovereign yield curve that acts as a barometer for other financial products' pricing. India has a well-developed primary and secondary government debt market, and government debt securities are by far the most liquid in the country.

Investors in Government Bonds So Far

In the Indian government debt market, large institutional players such as banks, mutual funds, and insurance companies are major investors.

Historically, commercial banks have been the largest investors in government securities market to meet their statutory liquidity ratio (SLR) requirements and use these government bonds as collateral to secure funding from the RBI (via Repos).

Source: RBI data

Primary dealers perform the function of market-making in the government debt securities market by offering a two-way (buy and sell) quote for these securities to make the G-sec market liquid.

The RBI also holds government bonds, because it must operate a market liquidity window and occasionally needs government bonds for open market operations (OMO).

After the changes in the regulations for non-banking finance companies (NBFCs) recently to achieve and maintain the targeted liquidity coverage ratio (LCR), the demand for G-sec from NBFCs has increased.

Other participants include cooperative banks, mutual funds, corporates, provident and pension funds, and foreign portfolio investors, among others.

Sources

Reserve Bank of India, Clearing Corporation of India Ltd