The government can consider issuing bonds for roads or railways as part of the Rs 12 lakh crore programme to retail investors with a simple payoff matrix. Tax-free bonds have resonated well with investors, so too would these issuances.
‘Bonds for the common man’ is the new message from the Reserve Bank of India (RBI) in its latest credit policy. This step by the central bank, it is believed, will help bring household savings into the Government Security (G-Sec) market and, hence, contribute to the supply of funds required for the government borrowing programme. Also, it gives more G-Sec market exposure to the retail segment. Will this work?
The success of any debt instrument, in the real world, rests on simplicity. When a deposit is made, it is known that it is for a period of three years with a return of 5.5%. If the holder wants to redeem before the maturity date, there is a penalty that can be paid, but the bank will repay the principal. The matrix is well known. The product is simple and hence straightforward.
Let us look at a corporate bond which is bought in the market. The individual sees the return which can be, say, 8% for an ‘AA’ rated bond. There is some doubt on whether the safety is assured, but if the rating is understood, one can go ahead with the purchase. If the person wants to sell the same, it can be tough as it may not be listed, and even if it is, there will be a price that may not be the same as the face value. The price varies depending on the environment and hence is inferior to a bank deposit in terms of certainty. Therefore, if not held to maturity, there is a risk of exit.
Now, the G-Sec market is slightly different. There are securities issued with nomenclature like the 5.77% 2030 bond which talks of the interest paid on face value of Rs 100. There is also the 5.85% 2030 bond. The yields on both of these are different, even though tenures are the same, i.e. 10-year bonds. For the 5.77% bond, the price is Rs 97.76 with an implicit yield of 6.08%. For the 5.85% bond, the price is Rs 98.60 with an implicit yield of 6.04%. What is the investor to make of it when entering the market?
If it is held till 2030, the investor will get the coupon rate on the investment every year. However, there would be several other similar sounding names with different yields. The problem is compounded when it has to be sold in the market. It can be done, provided there is trading taking place. Typically, in the secondary market, there are around 90 government securities that are listed. There are few that are traded in a vibrant manner. And these would be the benchmark securities for 5, 10, 15 years generally. Typically, two-thirds of the trades are in the 10-year G-Secs, which are the current benchmark. Another 20% is in the benchmarks for five years and 15 years. The rest really don’t matter. The problem comes to the fore even for these benchmarks in the t+1 year when the security becomes illiquid completely, as it now has with tenure of one less year.
Hence, the 5.77% benchmark for 10 years loses its importance once a new benchmark is announced and trading gets diluted and disappears after a full year passes. Therefore, exiting from this market is a big problem. The mindset, hence, must be that the retail holder will keep the security till maturity.
Now, look at the returns. The government offers the RBI bond for seven years with variable returns, which give a return of, say, 7.15% today, as it is 35 bps above the National Savings Certificate (NSC) rate. There are NSCs that give 6.8% for five years, and the senior citizen schemes that yield 7.4% for five years. The 6.05% yield on 10-year paper or 5.8% for five years is not even attractive compared to other government offerings, though they score over Fixed Deposits (FDs). But FD rates can increase over the next 5-10 years, while the G-Sec bond would be fixed at the yield of, say, 6.05%.
The curious part of these yields is that they are driven mainly by the monetary policy action that goes beyond the repo rate. Changes in the repo rate can drive deposit rates down as well as other savings instruments. But RBI being assigned the role of banker to the government has also led to the central bank continuously monitoring the liquidity situation to ensure that the government borrows at low rates. This will always keep yields down. Now, the small savings returns are linked to these yields and are kept slightly higher. The government bond scheme goes 35 bps above the small savings rates. Hence, unless one is out to trade in G-Secs, the nominal returns are not attractive. And retailers cannot trade as most of the securities are illiquid.
This is one reason why retail investors prefer to use the mutual funds route to get into the debt market. The gilt funds of different durations are ideal for retail investors as they have the fund manager taking decisions of handling the portfolio of the fund by changing the composition periodically depending on the objective of the fund. The same holds for corporate bonds where the mutual funds route is appropriate.
Therefore, while RBI’s decision to open up the market to retail investors is in the right spirit, the response will be indifference for these reasons. Issuance of special bonds for specific purposes with face value of Rs 100 and an interest rate of, say, 7% for five years will be easy to sell with the investor knowing that these are government commitments. Further, there has to be an exit option if there are no tax benefits for making them attractive. But the regular debt programme of the government may not find market-savvy investors that are in a position to discern the subtle nuances of the pricing of such paper and the exit options.
There will definitely be a good appetite for such simple products as households are wary of the very low interest rates offered by banks on deposits. The government can consider issuing bonds for roads or railways as part of the Rs 12 lakh crore programme to retail investors with a simple payoff matrix. Tax-free bonds have resonated very well with the investors, so too would these issuances. There is scope to think differently when planning to get convergence between retail investors and the government borrowing through these special bonds. The conventional G-Sec platform will not work.
The author is Chief economist, CARE Ratings, and the author of ‘Hits & Misses: The Indian Banking Story’. Views are personal