Government Securities Market in India – A Primer

Question 1

What is a Bond?

Answer 1

A bond is a debt instrument in which an investor loans money to an entity (typically corporate or government) which borrows the funds for a defined period of time at a variable or fixed interest rate. Bonds are used by companies, municipalities, states and sovereign governments to raise money to finance a variety of projects and activities. Owners of bonds are debt holders, or creditors, of the issuer.

Question 2

What is a Government Security (G-Sec)?

Answer 2

A Government Security (G-Sec) is a tradeable instrument issued by the Central Government or the State Governments. It acknowledges the Government’s debt obligation. Such securities are short term (usually called treasury bills, with original maturities of less than one year) or long term (usually called Government bonds or dated securities with original maturity of one year or more). In India, the Central Government issues both, treasury bills and bonds or dated securities while the State Governments issue only bonds or dated securities, which are called the State Development Loans (SDLs). G-Secs carry practically no risk of default and, hence, are called risk-free gilt-edged instruments.

Question 3

Treasury Bills (T-bills)

Answer 3

Treasury bills or T-bills, which are money market instruments, are short term debt instruments issued by the Government of India and are presently issued in three tenors, namely, 91 day, 182 day and 364 day. 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 say ₹ 98.20, that is, at a discount of say, ₹1.80 and would be redeemed at the face value of ₹100/-. The return to the investors is the difference between the maturity value or the face value (that is ₹100) and the issue price (for calculation of yield on Treasury Bills please see answer to question no. 26).

Question 4

Cash Management Bills (CMBs)

Answer 4

In 2010, Government of India, in consultation with RBI introduced a new short-term instrument, known as Cash Management Bills (CMBs), to meet the temporary mismatches in the cash flow of the Government of India. The CMBs have the generic character of T-bills but are issued for maturities less than 91 days.

Question 5

Dated G-Secs

Answer 5

Dated G-Secs are securities which carry a fixed or floating coupon (interest rate) which is paid on the face value, on half-yearly basis. Generally, the tenor of dated securities ranges from 5 years to 40 years.

Question 6

______________- acts as the registry / depository of G-Secs and deals with the issue, interest payment and repayment of principal at maturity

Answer 6

The Public Debt Office (PDO) of the Reserve Bank of India

Question 7

Most of the dated securities are

Answer 7

fixed coupon securities.

Question 8

If the coupon payment date falls on a Sunday or any other holiday, the coupon payment is made on

Answer 8

next working day

Question 9

However, if the maturity date falls on a Sunday or a holiday, the redemption proceeds are paid on

Answer 9

previous working day.

Question 10

Fixed Rate Bonds

Answer 10

These are bonds on which the coupon rate is fixed for the entire life (i.e. till maturity) of the bond. Most Government bonds in India are issued as fixed rate bonds.

Question 11

Floating Rate Bonds (FRB)

Answer 11

FRBs are securities which do not have a fixed coupon rate. Instead it has a variable coupon rate which is re-set at pre-announced intervals

Question 12

Floating Rate Bonds were first issued in

Answer 12

September 1995 in India.

Question 13

The variable coupon rate for payment of interest on this FRB 2024 was decided to be the average rate rounded off up to two decimal places, of

Answer 13

the implicit yields at the cut-off prices of the last three auctions of 182 day T- Bills, held before the date of notification

Question 14

Capital Indexed Bonds

Answer 14

These are bonds, the principal of which is linked to an accepted index of inflation with a view to protecting the Principal amount of the investors from inflation. A 5 year Capital Indexed Bond, was first issued in December 1997 which matured in 2002.

Question 15

Inflation Indexed Bonds (IIBs)

Answer 15

IIBs are bonds wherein both coupon flows and Principal amounts are protected against inflation. The inflation index used in IIBs may be Whole Sale Price Index (WPI) or Consumer Price Index (CPI). Globally, IIBs were first issued in 1981 in UK. In India, Government of India through RBI issued IIBs (linked to WPI) in June 2013. Since then, they were issued on monthly basis (on last Tuesday of each month) till December 2013. Based on the success of these IIBs, Government of India in consultation with RBI issued the IIBs (CPI based) exclusively for the retail customers in December 2013. Further details on IIBs are available on RBI website under FAQs.

Question 16

Bonds with Call/ Put Options

Answer 16

onds can also be issued with features of optionality wherein the issuer can have the option to buy-back (call option) or the investor can have the option to sell the bond (put option) to the issuer during the currency of the bond. It may be noted that such bond may have put only or call only or both options. The first G-Sec with both call and put option viz. 6.72% GS 2012 was issued on July 18, 2002 for a maturity of 10 years maturing on July 18, 2012. The optionality on the bond could be exercised after completion of five years tenure from the date of issuance on any coupon date falling thereafter. The Government has the right to buy-back the bond (call option) at par value (equal to the face value) while the investor had the right to sell the bond (put option) to the Government at par value on any of the half-yearly coupon dates starting from July 18, 2007.

Question 17

Special Securities

Answer 17

Under the market borrowing program, the Government of India also issues, from time to time, special securities to entities like Oil Marketing Companies, Fertilizer Companies, the Food Corporation of India, etc. (popularly called oil bonds, fertiliser bonds and food bonds respectively) as compensation to these companies in lieu of cash subsidies These securities are usually long dated securities and carry a marginally higher coupon over the yield of the dated securities of comparable maturity. These securities are, however, not eligible as SLR securities but are eligible as collateral for market repo transactions. The beneficiary entities may divest these securities in the secondary market to banks, insurance companies / Primary Dealers, etc., for raising funds.

Government of India has also issued Bank Recapitalisation Bonds to specific Public Sector Banks in 2018. These securities are named as Special GoI security and are non-transferable and are not eligible investment in pursuance of any statutory provisions or directions applicable to investing banks. These securities can be held under HTM portfolio without any limit.

Question 18

STRIPS

Answer 18

Separate Trading of Registered Interest and Principal of Securities.

Question 19

STRIPS

Answer 19

STRIPS are the securities created by way of separating the cash flows associated with a regular G-Sec i.e. each semi-annual coupon payment and the final principal payment to be received from the issuer, into separate securities. They are essentially Zero Coupon Bonds (ZCBs). However, they are created out of existing securities only and unlike other securities, are not issued through auctions. Stripped securities represent future cash flows (periodic interest and principal repayment) of an underlying coupon bearing bond. Being G-Secs, STRIPS are eligible for SLR. All fixed coupon securities issued by Government of India, irrespective of the year of maturity, are eligible for Stripping/Reconstitution, provided that the securities are reckoned as eligible investment for the purpose of Statutory Liquidity Ratio (SLR) and the securities are transferable. The detailed guidelines of stripping/reconstitution of government securities is available in RBI notification IDMD.GBD.2783/08.08.016/2018-19 dated May 3, 2018. For example, when ₹100 of the 8.60% GS 2028 is stripped, each cash flow of coupon (₹ 4.30 each half year) will become a coupon STRIP and the principal payment (₹100 at maturity) will become a principal STRIP. These cash flows are traded separately as independent securities in the secondary market. STRIPS in G-Secs ensure availability of sovereign zero coupon bonds, which facilitate the development of a market determined zero coupon yield curve (ZCYC). STRIPS also provide institutional investors with an additional instrument for their asset liability management (ALM). Further, as STRIPS have zero reinvestment risk, being zero coupon bonds, they can be attractive to retail/non-institutional investors. Market participants, having an SGL account with RBI can place requests directly in e-kuber for stripping/reconstitution of eligible securities (not special securities). Requests for stripping/reconstitution by Gilt Account Holders (GAH) shall be placed with the respective Custodian maintaining the CSGL account, who in turn, will place the requests on behalf of its constituents in e-kuber.

Question 20

Sovereign Gold Bond (SGB)

Answer 20

SGBs are unique instruments, prices of which are linked to commodity price viz Gold. SGBs are also budgeted in lieu of market borrowing. The calendar of issuance is published indicating tranche description, date of subscription and date of issuance. The Bonds shall be denominated in units of one gram of gold and multiples thereof. Minimum investment in the Bonds shall be one gram with a maximum limit of subscription per fiscal year of 4 kg for individuals, 4 kg for Hindu Undivided Family (HUF) and 20 kg for trusts and similar entities notified by the Government from time to time, provided that (a) in case of joint holding, the above limits shall be applicable to the first applicant only; (b) annual ceiling will include bonds subscribed under different tranches during initial issuance by Government and those purchased from the secondary market; and (c) the ceiling on investment will not include the holdings as collateral by banks and other Financial Institutions. The Bonds shall be repayable on the expiration of eight years from the date of issue of the Bonds. Pre-mature redemption of the Bond is permitted after fifth year of the date of issue of the Bonds and such repayments shall be made on the next interest payment date. The bonds under SGB Scheme may be held by a person resident in India, being an individual, in his capacity as an individual, or on behalf of minor child, or jointly with any other individual. The bonds may also be held by a Trust, HUFs, Charitable Institution and University. Nominal Value of the bonds shall be fixed in Indian Rupees on the basis of simple average of closing price of gold of 999 purity published by the India Bullion and Jewelers Association Limited for the last three business days of the week preceding the subscription period. The issue price of the Gold Bonds will be ₹ 50 per gram less than the nominal value to those investors applying online and the payment against the application is made through digital mode. The Bonds shall bear interest at the rate of 2.50 percent (fixed rate) per annum on the nominal value. Interest shall be paid in half-yearly rests and the last interest shall be payable on maturity along with the principal. The redemption price shall be fixed in Indian Rupees and the redemption price shall be based on simple average of closing price of gold of 999 purity of previous 3 business days from the date of repayment, published by the India Bullion and Jewelers Association Limited. SGBs acquired by the banks through the process of invoking lien/hypothecation/pledge alone shall be counted towards Statutory Liquidity Ratio. The above subscription limits, interest rate discount etc. are as per the current scheme and are liable to change going forward.

Question 21

7.75% Savings (Taxable) Bonds, 2018:

Answer 21

Government of India has decided to issue 7.75% Savings (Taxable) Bonds, 2018 with effect from January 10, 2018 in terms of GoI notification F.No.4(28) - W&M/2017 dated January 03, 2018 and RBI issued notification vide IDMD.CDD.No.1671/13.01.299/2017-18 dated January 3, 2018. These bonds may be held by (i) an individual, not being a Non-Resident Indian-in his or her individual capacity, or in individual capacity on joint basis, or in individual capacity on any one or survivor basis, or on behalf of a minor as father/mother/legal guardian and (ii) a Hindu Undivided Family. There is no maximum limit for investment in these bonds. Interest on these Bonds will be taxable under the Income Tax Act, 1961 as applicable according to the relevant tax status of the Bond holders. These Bonds will be exempt from wealth-tax under the Wealth Tax Act, 1957. These Bonds will be issued at par for a minimum amount of ₹1,000 (face value) and in multiples thereof. RBI vide its notification IDMD.CDD No.21/13.01.299/2018-19 dated July 2, 2018 has issued Master Directions on Relief/Savings Bonds providing details on appointment/delisting of brokers, payment and rates of brokerage for saving bonds and nomination facility etc.

Question 22

State Development Loans (SDLs)

Answer 22

State Governments also raise loans from the market which are called SDLs. SDLs are dated securities issued through normal auction similar to the auctions conducted for dated securities issued by the Central Government (please see question 3). Interest is serviced at half-yearly intervals and the principal is repaid on the maturity date. Like dated securities issued by the Central Government, SDLs issued by the State Governments also qualify for SLR. They are also eligible as collaterals for borrowing through market repo as well as borrowing by eligible entities from the RBI under the Liquidity Adjustment Facility (LAF) and special repo conducted under market repo by CCIL. State Governments have also issued special securities under “Ujjwal Discom Assurance Yojna (UDAY) Scheme for Operational and Financial Turnaround of Power Distribution Companies (DISCOMs)” notified by Ministry of Power vide Office Memorandum (No 06/02/2015-NEF/FRP) dated November 20, 2015.

Question 23

Why should one invest in G-Secs?

Answer 23

Holding of cash in excess of the day-to-day needs (idle funds) does not give any return. Investment in gold has attendant problems in regard to appraising its purity, valuation, warehousing and safe custody, etc. In comparison, investing in G-Secs has the following advantages:

Besides providing a return in the form of coupons (interest), G-Secs offer the maximum safety as they carry the Sovereign’s commitment for payment of interest and repayment of principal.

They can be held in book entry, i.e., dematerialized/ scripless form, thus, obviating the need for safekeeping. They can also be held in physical form.

G-Secs are available in a wide range of maturities from 91 days to as long as 40 years to suit the duration of varied liability structure of various institutions.

G-Secs can be sold easily in the secondary market to meet cash requirements.

G-Secs can also be used as collateral to borrow funds in the repo market.

Securities such as State Development Loans (SDLs) and Special Securities (Oil bonds, UDAY bonds etc) provide attractive yields.

The settlement system for trading in G-Secs, which is based on Delivery versus Payment (DvP), is a very simple, safe and efficient system of settlement. The DvP mechanism ensures transfer of securities by the seller of securities simultaneously with transfer of funds from the buyer of the securities, thereby mitigating the settlement risk.

G-Sec prices are readily available due to a liquid and active secondary market and a transparent price dissemination mechanism.

Question 24

Besides banks, insurance companies and other large investors, smaller investors like Co-operative banks, Regional Rural Banks, Provident Funds are also required to statutory hold G-Secs as indicated below:

Answer 24

A. Primary (Urban) Co-operative Banks (UCBs)

2.2 Section 24 (2A) of the Banking Regulation Act 1949, (as applicable to co-operative societies) provides that every primary (urban) cooperative bank shall maintain liquid assets, the value of which shall not be less than such percentage as may be specified by Reserve Bank in the Official Gazette from time to time and not exceeding 40% of its DTL in India as on the last Friday of the second preceding fortnight (in addition to the minimum cash reserve ratio (CRR) requirement). Such liquid assets shall be in the form of cash, gold or unencumbered investment in approved securities. This is referred to as the Statutory Liquidity Ratio (SLR) requirement. It may be noted that balances kept with State Co-operative Banks / District Central Co-operative Banks as also term deposits with public sector banks are now not eligible for being reckoned for SLR purpose w.e.f April 1, 2015.

B. Rural Co-operative Banks

2.3 As per Section 24 of the Banking Regulation Act 1949, the State Co-operative Banks (SCBs) and the District Central Co-operative Banks (DCCBs) are required to maintain assets as part of the SLR requirement in cash, gold or unencumbered investment in approved securities the value of which shall not, at the close of business on any day, be less than such per cent, as prescribed by RBI, of its total net demand and time liabilities. DCCBs are allowed to meet their SLR requirement by maintaining cash balances with their respective State Co-operative Bank.

C. Regional Rural Banks (RRBs)

2.4 Since April 2002, all the RRBs are required to maintain their entire Statutory Liquidity Ratio (SLR) holdings in Government and other approved securities.

D. Provident funds and other entities

2.5 The non- Government provident funds, superannuation funds and gratuity funds are required by the Central Government, effective from January 24, 2005, to invest 40% of their incremental accretions in Central and State G-Secs, and/or units of gilt funds regulated by the Securities and Exchange Board of India (SEBI) and any other negotiable security fully and unconditionally guaranteed by the Central/State Governments. The exposure of a trust to any individual gilt fund, however, should not exceed five per cent of its total portfolio at any point of time. The investment guidelines for non- Government PFs have been recently revised in terms of which minimum 45% and up to 50% of investments are permitted in a basket of instruments consisting of (a) G-Secs, (b) Other securities (not in excess of 10% of total portfolio) the principal whereof and interest whereon is fully and unconditionally guaranteed by the Central Government or any State Government SDLs and (c) units of mutual funds set up as dedicated funds for investment in G-Secs (not more than 5% of the total portfolio at any point of time and fresh investments made in them shall not exceed 5% of the fresh accretions in the year), effective from April 2015.

Question 25

How are the G-Secs issued?

Answer 25

3.1 G-Secs are issued through auctions conducted by RBI. Auctions are conducted on the electronic platform called the E-Kuber, the Core Banking Solution (CBS) platform of RBI. Commercial banks, scheduled UCBs, Primary Dealers (a list of Primary Dealers with their contact details is given in Annex 2), insurance companies and provident funds, who maintain funds account (current account) and securities accounts (Subsidiary General Ledger (SGL) account) with RBI, are members of this electronic platform. All members of E-Kuber can place their bids in the auction through this electronic platform. The results of the auction are published by RBI at stipulated time (For Treasury bills at 1:30 PM and for GoI dated securities at 2:00 PM or at half hourly intervals thereafter in case of delay). All non-E-Kuber members including non-scheduled UCBs can participate in the primary auction through scheduled commercial banks or PDs (called as Primary Members-PMs). For this purpose, the UCBs need to open a securities account with a bank / PD – such an account is called a Gilt Account. A Gilt Account is a dematerialized account maintained with a scheduled commercial bank or PD. The proprietary transactions in G-Secs undertaken by PMs are settled through SGL account maintained by them with RBI at PDO. The transactions in G-Secs undertaken by Gilt Account Holders (GAHs) through their PMs are settled through Constituent Subsidiary General Ledger (CSGL) account maintained by PMs with RBI at PDO for its constituent (e.g., a non-scheduled UCB).

3.2 The RBI, in consultation with the Government of India, issues an indicative half-yearly auction calendar which contains information about the amount of borrowing, the range of the tenor of securities and the period during which auctions will be held. A Notification and a Press Communique giving exact particulars of the securities, viz., name, amount, type of issue and procedure of auction are issued by the Government of India about a week prior to the actual date of auction. RBI places the notification and a Press Release on its website (www.rbi.org.in) and also issues advertisements in leading English and Hindi newspapers. Auction for dated securities is conducted on Friday for settlement on T+1 basis (i.e. securities are issued on next working day i.e. Monday). The investors are thus given adequate time to plan for the purchase of G-Secs through such auctions. A specimen of a dated security in physical form is given at Annex 1. The details of all the outstanding dated securities issued by the Government of India are available on the RBI website at http://www.rbi.org.in/Scripts/financialmarketswatch.aspx. A sample of the auction calendar and the auction notification are given in Annex 3 and 4, respectively.

3.3 The Reserve Bank of India conducts auctions usually every Wednesday to issue T-bills of 91day, 182 day and 364 day tenors. Settlement for the T-bills auctioned is made on T+1 day i.e. on the working day following the trade day. The Reserve Bank releases a quarterly calendar of T-bill issuances for the upcoming quarter in the last week of the preceding quarter. e.g. calendar for April-June period is notified in the last week of March. The Reserve Bank of India announces the issue details of T-bills through a press release on its website every week.

3.4 Like T-bills, Cash Management Bills (CMBs) are also issued at a discount and redeemed at face value on maturity. The tenor, notified amount and date of issue of the CMBs depend upon the temporary cash requirement of the Government. The tenors of CMBs is generally less than 91 days. The announcement of their auction is made by Reserve Bank of India through a Press Release on its website. The non-competitive bidding scheme (referred to in paragraph number 4.3 and 4.4 under question No. 4) has not been extended to CMBs. However, these instruments are tradable and qualify for ready forward facility. Investment in CMBs is also reckoned as an eligible investment in G-Secs by banks for SLR purpose under Section 24 of the Banking Regulation Act, 1949. First set of CMB was issued on May 12, 2010

3.5 Floatation of State Government Loans (State Development Loans)

In terms of Sec. 21A (1) (b) of the Reserve Bank of India Act, 1934, the RBI may, by agreement with any State Government undertake the management of the public debt of that State. Accordingly, the RBI has entered into agreements with 29 State Governments and one Union Territory (UT of Puducherry) for management of their public debt. Under Article 293(3) of the Constitution of India (Under section 48A of Union territories Act, in case of Union Territory), a State Government has to obtain the permission of the Central Government for any borrowing as long as there is any outstanding loan that the State Government may have from the Centre.

Market borrowings are raised by the RBI on behalf of the State Governments to the extent of the allocations under the Market Borrowing Program as approved by the Ministry of Finance in consultation with the Planning Commission.

RBI, in consultation with State Governments announces, the indicative quantum of borrowing on a quarterly basis. All State Governments have issued General notifications which specify the terms and conditions for issue of SDL. Before every auction, respective state governments issue specific notifications indicating details of the securities being issued in the particular auction. RBI places a press release on its website and also issues advertisements in leading English and vernacular newspapers of the respective states.

Currently, SDL auctions are held generally on Tuesdays every week. As in case of Central Government securities, auction is held on the E-Kuber Platform. 10% of the notified amount is reserved for the retail investors under the non-competitive bidding.

Question 26

What are the different types of auctions used for issue of securities? What is switch/conversion of Government Securities through auction?