Government Bonds | Part 2

Advantages of Investing in Government Bonds

1. Sovereign Guarantee 

Government Bonds hold a premium status due to their financial stability and assured returns. As formal declarations of the government’s debt obligations, G-Secs represent the issuer’s commitment to repayment under the specified terms.

2. Regular source of income

According to RBI regulations, interest on Government Bonds is distributed to bondholders every six months. This offers investors a steady income stream while utilizing their idle funds effectively. This makes them best suited for investors seeking a predictable flow of regular income.

3. Low minimum investment

Most government bonds have a low minimum investment limit of Rs. 1,000, and investors can increase their contribution in multiples of Rs. 1,000. This makes them accessible to investors seeking to park their funds in a fixed-income asset without making a substantial contribution.

4. Tax Benefits

Public sector entities like the NTPC Limited, NHAI, Indian Railways and others issue tax-free bonds. These bonds offer the added advantage of tax exemptions on the interest income earned on the investment. Additionally, no TDS is applicable on these bonds. Sovereign gold bonds also enjoy certain tax benefits. If SGBs are held for 8 years, no capital gains tax is applicable on them upon maturity. Maturity proceeds from SGBs are also tax-free when collected on maturity.

Also Read: Government Bonds | Part 1

5. Repayment Guarantee

Returns from government bonds are certain since they are administered by the RBI and backed by the Indian Government’s sovereign guarantee. In other words, the risk of default is almost non-existent as compared to corporate bonds. This makes government bonds one of the safest investment options in the country, especially for risk-averse investors like retirees.

Do Government Bonds Carry Any Risks?

While you may be exposed to little or no risk of default if you invest in government bonds, there are certain risks that you should be aware of.

They include the following:

1. Interest Rate Risks

Interest rate risk is a key concern for government bond investors since bond prices move inversely to interest rates—rising rates cause bond prices to fall, leading to potential losses. Economic conditions heavily influence interest rates; central banks may increase them during growth to control inflation and lower them in recessions to stimulate borrowing. Monitoring economic indicators and market trends is essential but challenging for predicting rate fluctuations.

2. Inflation Risks

Inflation risk arises when inflation exceeds a bond’s yield, eroding real returns and reducing purchasing power. For example, if an investor holds a 10-year government bond with a fixed 5% yield and inflation spikes from 4% to 10% after five years, the real return turns negative. This also devalues the bond, leading to potential capital loss if sold before maturity. If inflation stays high, future cash flows lose value. To mitigate this risk, investors can consider inflation-indexed bonds, which adjust principal and interest payments to inflation.

3. Liquidity Risk

Liquidity risk occurs when a bond cannot be easily sold without a significant loss due to low trading volume or market depth. Investors who want to sell bonds before maturity may find it difficult to find buyers or accept a lower price, especially in periods of low liquidity. In extreme cases, they may face substantial losses. However, investors who hold bonds until maturity are unaffected, as they will receive the full principal and interest regardless of market conditions.

4. Credit risk

Credit risk arises when a bond issuer defaults, failing to repay principal and interest. While government bonds are generally safer than corporate bonds, defaults can still occur due to factors like political instability, high debt, or economic downturns.

5. Currency Risk

Investing in foreign government bonds exposes investors to currency risk, where fluctuations in exchange rates impact returns. If the bond’s currency depreciates against the investor’s home currency, returns decline. Factors like exchange rate shifts, political instability, and economic conditions can further increase this risk.

From Where to Buy Government Bonds

You can purchase government bonds in India using one of the following avenues:

1. Primary Auctions

When the government issues new bonds, it conducts primary auctions where it sells these bonds directly to investors, who can participate in these auctions through various channels, including:

• Banks: Most banks in India offer the facility to buy government bonds for their customers using their online platform to place a bid in the primary auction.
• Primary Dealers: Primary Dealers are financial institutions authorized by the Reserve Bank of India (RBI) to participate directly in government securities auctions. Retail investors can also approach these PDs to submit bids in the primary auctions.
• National Stock Exchange (NSE) and Bombay Stock Exchange (BSE): Retail investors can participate in the primary auctions through the NSE and BSE platforms. One must have a trading account with the registered broker and follow the bidding process.

Also Read: Debunking Financial Myths: The Truth About Smart Money Management

2. Secondary Market

After the Primary issuance, government bonds are available for trading in the secondary market, where investors can buy and sell bonds that have already been issued.

• Stock Exchange: Government bonds are listed on stock exchanges like NSE and BSE. Investors can place orders through their trading accounts with registered brokers.
• Electronic Trading Platforms: Some banks and financial institutions offer online platforms for buying government bonds.
• Bond Funds / Mutual Funds: Another way to invest in government bonds indirectly is by investing in bond funds or mutual funds that primarily hold government bonds in their portfolio. This allows you to invest in a diversified bond portfolio managed by professional fund managers.

Who Should Invest in Government Bonds?

Government Bonds are among the safest investment options in India due to their sovereign guarantee. They are ideal for risk-averse investors who prefer security over the uncertainty of market-linked instruments. These bonds also serve as a good long-term investment for those with little experience in stock market investments.

Investors looking to reduce risk in their portfolio while earning stable returns can allocate a portion of their funds to Government Bonds. To encourage retail participation, the Indian government has simplified the subscription process and increased awareness of G-Secs.

One such initiative is the Non-Competitive Bidding (NCB) system, which allows investors to bid and invest easily through select websites and mobile apps using a Demat account. This makes Government Bonds a suitable option for those looking to diversify their investments or start their investment journey.

Conclusion

Government bonds in India present a range of investment opportunities for investors seeking stable and relatively low-risk options. These securities, issued and backed by the government, cater to varying investment horizons and risk preferences. From long-term government of India Bonds to short-term Treasury Bills, investors can choose instruments that align with their financial goals. Additionally, specialized offerings like Sovereign Gold Bonds and capital Gain Bonds provide avenues for diversification and potential tax benefits. It is essential to consider individual financial needs and seek guidance from financial advisors to make investment decision