GOI Floating Rate Savings Bonds 2020 (Taxable): Really do you need to invest in them..?

Let us discuss it in detail.

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History:

Till recently, especially post COVID outbreak and once the RBI started a series of rate cuts to improve the liquidity in the system, the erstwhile 7.75% GOI (Taxable) bonds became a very popular investment option for many conservative investors including retired people. There was a huge surge in subscriptions to these bonds in the recent past.

The Govt and the RBI have been keen on reducing the interest rate (the cost of borrowing) to kick start the Credit off-take and the demand cycle in the economy. The natural side effect of this thought process and action is the sharp reduction in interest rates on all the deposits schemes.

Firstly, the Govt reduced interest rates on Post office small savings schemes followed by the Senior Citizen Savings Scheme, PMVVY ( Pradhan Mantri Vaya Vandana Yojana), and finally, in May 2020, Govt stopped accepting subscriptions for 7.75% GOI (taxable) Bonds too.

This paved the way for the new version of Taxable Bonds.

GOI Floating Rate (Taxable) Bonds 2020:

The Govt has brought in certain changes. Therefore these bonds may not look so simple and straight forward like previous versions of Taxable Bonds. This time around, the Govt is offering a Floating Rate- Linked to a certain Benchmark, instead of absolute fixed returns like earlier days. Mostly all the other conditions remain the same.

Salient Features :

1. They enjoy a sovereign guarantee for repayment of Interest and Capital. Hence, investors can have a sense of 100% safety.
2. Interest is pegged at Prevailing Interest on NSC (National Savings Certificate) with a spread of (+) 0.35%. The present Interest rate for NSC is 6.80%. Hence, for July 2020 to Jan 2021 period, it is fixed as 7.15%. (i.e 6.8%+0.35%) Yes, it is reset every six months based on the current NSC rate of interest.
3. Interest paid only on half-yearly mode. The Cumulative option is discontinued.
4. Tenure of the bonds remains to be 7 years.
5. Only Resident Individuals (excluding NRIs), Minors, and HUF can invest.
6. These bonds are not transferable and can not be mortgaged to take loans. They are not even traded in the secondary market. Hence, one should be clear about the lack of liquidity in these instruments.
7. The Interest received is taxable at one’s applicable tax slab.
8. The prematurity option is available only for senior citizens with a minor penalty in the form of some deduction in accrued interest in the previous 6 months.

People in the age bracket of 60 -70 years can opt for premature withdrawal only after 6 years from the date of issuance, whereas who are between 70–80 years old can pre-close it after 5 years. And who are above 80 years, can withdraw prematurely only after 4 years.

9. They are available for subscription from 1st July 2020.

Who may consider investing in these Bonds?

These are very unique among Govt bonds, come with no fixed returns. In a way, it is good for both, Govt as well as investors.

How..?

The Govt has learned a lesson or two, based on their previous experiences with Unit -64 and Rajalakshmi Schemes of yore, where UTI was not able to honor its commitments. And the Govt had to bail it out and restructure UTI, based on recommendations of Deepak Parikh committee. Hence, now the Govt is playing safe by offering a fixed spread over the NSC rate of interest, rather than an absolute fixed rate of Interest. If interest rates continue to fall in the future, its commitment will not bloat unreasonably at the time of maturity and create a huge gap between current interest rates and the yield offered to these bondholders.

Similarly, it may not be a wise decision on part of Investors, to invest now during such a low-interest regime, and lock their money for the next 7 years. We are witnessing one of the lowest interest regimes in history.

Please remember due to the COVID pandemic and its after-effects, all the Central banks, including Reserve Bank of India( RBI), have reduced the interest rates drastically to increase the liquidity. Most of the Experts opine that RBI may have resort to one more rate cut, at best.

Later, once the demand cycle and credit offtake start picking up, the RBI will start increasing Interest rate to contain inflation and money supply. Once, this happens, the Investors of floating-rate bonds like this will also benefit. In such circumstances, naturally, the returns on these bonds will also increase.

Hence, anyone who does not have a liquidity requirement for the next 7 years,(please be absolutely clear on this aspect) and looking safety of capital with little over NSC/ SBI FD’s one-year interest rate, may consider this.

The Retired people, who are content with this sort of returns, can take partial exposure. It also offers half-yearly interest. This would help to meet some of their cash flow requirements.

Even others, who are overweight on other assets ( example: Equity, Real Estate, etc), may diversify into these bonds, as part of their asset allocation to reach their goals which more 7 years away.

In short, it is a Sovereign guarantee bond with a floating rate of returns, meant for a certain kind of people and their needs.