Traded securities can be broadly grouped into two categories: debt, better known as bonds, and equity or shares. However, bonds, the main alternative to shares, often receive less investor attention. Essentially, debt securities are loans made by an investor to the issuer, typically a corporation or government. Since debt securities are loans, they have interest or coupon rate attached to them. As bond investors receive interest at regular intervals, debt securities are also known as fixed-income securities. 

Bonds can be further classified into corporate and government bonds. Of all investment categories available in India, government bonds, popularly known as G-secs, are considered the safest as they carry the sovereign guarantee. This blog post will focus on long-term government bonds issued by the government of India to fund its capital expenditure. 

Read on to learn more about long-term bonds, what they are, and how they make a good investment alternative. 

Government bonds

Governments need money to fund various development projects. They issue long-term bonds to fund long-term capital expenditure. Long-term government bonds are considered the safest form of investment as they carry a sovereign warranty. The negligible default risk makes government bonds attractive for individual as well as institutional investors looking for a safe investment alternative and fixed income. 

In India, government bonds are issued solely by the Reserve Bank of India (RBI) and they come in various forms to meet the short- and long-term funding needs of the government. This blog post will explore the types of government bonds available in India, their advantages and disadvantages, and who should consider investing in them.

Types of government bonds in India

Government bonds (G-secs) are classified based on their maturity. The government of India issues debt securities with tenures ranging from overnight to up to 40 years. We will discuss g-secs with a maturity of more than a year, which are also known as long-term government bonds. 

Fixed-rate bonds

Fixed-rate bonds are the most common type of government bond. They offer a predetermined interest rate that remains constant through the bond’s tenure. Investors receive regular interest payments, typically semi-annually or annually, providing predictable returns. The principal amount is returned at maturity, enhancing their appeal to conservative investors who seek stable income. 

An example of a fixed rate bond would be: 8.24%GS2018 was issued on April 22, 2008, for a tenor of 10 years maturing on April 22, 2018. Coupons 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.

Floating Rate Bonds (FRBs)

Floating rate bonds (FRBs), as the name suggests, have a variable coupon rate which is re-set at pre-announced intervals, say, every six months or one year. 

In India, FRBs were first issued in September 1995. For example, an FRB was issued on November 07, 2016, for a tenor of 8 years, thus maturing on November 07, 2024. The first variable coupon rate for payment of interest on this FRB 2024 was set to be the average rate of the implicit yields at the cut-off prices of the last three auctions of 182-day T-bills, held before the date of notification. 

The subsequent semi-annual coupon rates were announced to be the average rate of the implicit yields at the cut-off prices of the last three auctions of 182-day T-Bills held up to the commencement of the respective semi-annual coupon periods.

The Floating Rate Bond can also carry the coupon, which will have a base rate plus a fixed spread, to be decided by way of auction mechanism. The spread will be fixed throughout the tenure of the bond. 

Sovereign Gold Bonds (SGBs)

Sovereign Gold Bonds are unique investment instruments that allow investors to invest in gold without holding physical gold. These bonds are denominated in grams of gold and offer a fixed interest rate on the invested amount. Additionally, SGBs provide capital appreciation based on the prevailing gold prices at maturity. This makes them an attractive option for those looking to invest in gold and also earn interest.

Inflation-indexed bonds (IIBs)

Inflation-indexed bonds are designed to protect investors from inflation risks. IIBs protect both  

coupon flows and the principal amount against inflation.

The principal value of these bonds is adjusted for inflation based on an accepted index, ensuring that the purchasing power of the investment is maintained over time. These bonds typically offer a fixed interest rate on top of the inflation-adjusted principal, making them suitable for investors concerned about inflation eroding their returns.

7.75% GOI Savings Bond

The 7.75% GOI Savings Bond is a specific type of government bond that offers a fixed interest rate of 7.75%. Initially launched to replace older savings bonds, these bonds have a maturity period of seven years and are available for a minimum investment amount. They provide a stable return and are suitable for risk-averse investors looking for predictable income streams. 

Bonds with Call or Put Option

Bonds can also be issued with features of optionality. Here, the issuer has the option to buy back (call option) or the investor has the option to sell the bond (put option) to the issuer during the tenure of the bond. It may be noted that such a bond may have put only or call only or both options. These features can enhance liquidity and give investors more control over their investments.

Zero-Coupon Bonds

Zero-coupon bonds do not pay periodic interest payments like traditional bonds. Instead, they are issued at a discount to their face value and mature at face value. 

The RBI issues treasury bills (T-bills) for maturities of 91 days, 182 days, and 364 days to meet the short-term funding requirements of the government as well as manage liquidity in the economy. Treasury bills are zero coupon securities and pay no interest. Instead, 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 ₹98.20, that is, at a discount of ₹1.80 and would be redeemed at the face value of ₹100/-.

The RBI does not issue zero coupon bonds for maturities over a year. T-bills are the only zero-coupon securities issued by the RBI. 

Advantages of investing in government bonds

Here are some of the advantages of investing in long-term government bonds: 

Sovereign guarantee

G-secs are issued by the RBI on behalf of the government of India. The long-term government bonds are backed by the government of India and thus come with a sovereign guarantee. The likelihood of default is minimal since the government can raise funds by taxation or by borrowing. This makes long-term bonds the safest mode of investment in India. The interest rate offered by fixed-rate bonds is considered the risk-free rate of return for the Indian market. 

Regular source of income

Debt securities such as government bonds are also known as fixed-income securities as they come with coupon rates. This is the rate of interest that investors will receive at regular intervals. The interest payments at regular intervals help generate a steady source of income for the investor. This is helpful for retirees or organizations looking to generate regular income by investing in safe investment instruments. 

Inflation-adjusted

Inflation-indexed bonds adjust interest rates to factor in the impact of inflation on both principal and interest rates. These bonds extend the benefits of inflation-adjusted returns. Other long-term bonds such as the fixed-rate bond do not offer this benefit. 

Disadvantages of investing in government bonds

Long-term government bonds are a popular risk-free mode of investment preferred by institutional and individual investors alike. But G-secs have some downsides which are discussed below.

Low rate of return

The rule of thumb in finance is high risk; high returns. Returns on investment are a function of risk-reward. Since long-term government securities are the safest investment alternatives available in India, they also have the lowest rate of return. 

This makes long-term government securities unsuitable for young investors looking for a higher rate of return with considerable safety. 

Economy, rising interest rates make bonds unattractive

In times of rising interest rates or changing economic conditions, existing government bonds may become less attractive compared to newly issued ones offering higher yields. This can lead to fluctuations in bond prices and may impact liquidity if investors wish to sell their holdings before maturity. 

While the loss of relevance is a disadvantage in the shorter run, g-secs offered for maturities of over 10 years will enjoy the benefit of higher rates. This is because interest rates in the economy reduce as the country develops. For instance, as India moves ahead in its development journey, interest rates will fall in the long term. Thus, investors in long-term g-secs may get the advantage of higher coupon rates even when interest rates in the economy decline over time.

Who should invest in government bonds?

Government bonds are suitable for various types of investors:

• Conservative investors: Long-term bonds are perfect for investors looking for capital preservation over capital appreciation as they are the safest investment alternatives available in the market offering stable returns.
• Retirees: Individuals looking for regular income streams during retirement can benefit from the predictable cash flows provided by government bond interest payments.
• Long-term investors: Investors with long-term goals may choose inflation-indexed bonds to preserve capital and hedge against inflation.
• Diversification seekers: Including government bonds in an investment portfolio can help balance risk while providing some income in the form of coupon payments. 

To conclude, long-term government bonds are an important segment of India’s financial landscape. While bonds come with inherent advantages such as safety and regular income, potential investors should also consider their downsides before making investment decisions. By understanding these dynamics, individuals can make informed choices about including government bonds in their portfolio.