Fixed income indtruments are quite popular among Indian households due to their low risk features. However the Indian debt markets are largely wholesale markets dominated by institutional investors. There are however a few retail products that are offered from time to time. Some bonds are offered to retail investors but do not have a liquid secondary market. Therefore retail investors do not participate in such bond issues or end up buying and holding the bonds to maturity.
The following are fixed income bonds and deposits available to retail investors:
- Government securities
- Corporate bonds
- Company deposits
- Bank deposits
Government Securities
Government securities (G-secs) are issued by the RBI on behalf of the government. G-secs represent the borrowing of the government, mostly to meet the deficit. Deficit is the gap between the government’s income and expenditure. G-secs are issued through auctions that are announced by RBI from time to time. Banks, mutual funds, insurance companies, provident fund trusts and such institutional investors are large and regular buyers of G-secs. With a view to encouraging retail participation, the government has reserved 5% of the auction amount in every auction for non-competitive buyers, including retail investors.
In order to buy G-secs, retail investors have to open a Constituent Securities General Ledger (CSGL) account with their bank or any other holder of SGL (Securities General Ledger) accounts. The CSGL account is held as part of the accounts of the offering bank, in which the G-secs are held as electronic entries in demat form. Investors can also transfer the G-secs to their normal demat account, after buying them. The minimum investment amount is Rs.10,000. Investors can apply for buying G-secs through their SGL-holding bank and make the payment through their bank. The price at which the retail investors are allotted G-secs as non-competitive bidders will be the weighted average price of the successful bids in the auction.
There is no cumulative option in a G-sec. Interest is paid out on pre-specified dates into the designated bank account of the investor. Interest is not subject to TDS but is fully taxable. Redemption proceeds are also paid into the bank account. Though there is a retail debt market segment in which all issued G-secs can be traded, there is limited liquidity for small lots of G-secs. The institutional market where the trading lot is Rs.5 crore is quite active. Retail investors may have to hold the G-secs to maturity.
Inflation-Indexed Bonds
Inflation Indexed Bonds (IIB) are a category of government securities issued by the RBI which provides inflation protected returns to the investors. These bonds have a fixed real coupon rate which is applied to the inflation adjusted principal on each interest payment date. On maturity, the higher of the face value and inflation adjusted principal is paid out to the investor. Thus, the coupon income as well as the principal is adjusted for inflation. The inflation adjustment to the principal is done by multiplying it with the index ratio. The index ratio is calculated by dividing the reference index on the settlement date by the reference index on the date of issue of the security. The Wholesale Price Index (WPI) or the Consumer Price Index (CPI) is the inflation measure that is considered for the calculation of the index ratio for these bonds.
Another category of inflation-indexed instruments issued by the RBI for retail investors were the Inflation-Indexed National Saving Securities-Cumulative 2013. These bonds of 10-year tenor were available to retail resident individuals, minors, HUFs, and charities among others. The bond carries a fixed interest of 1.5% and an inflation rate calculated on the basis of the Consumer Price Index (CPI). The interest is compounded every six months and cumulated and paid with the principal on maturity. The fixed rate of interest is the floor and will be paid even if there is deflation. The interest is taxable according to the tax status of the investor.
The minimum investment was Rs.5000 and the maximum Rs.500000 per applicant. The bonds were issued in the form of a credit to the Bond Ledger Account (BLA) and a certificate is issued to the holder. The bonds are not listed or traded on the secondary markets and can be transferred prior to maturity only on the death of the holder to the nominees or legal heirs.
Corporate Bonds
Corporate bonds are debt instruments issued by private and public sector companies. They are issued for tenors ranging from two years to 15 years. The more popular tenors are 5-year and 7-year bonds. Most corporate bonds are issued to institutional investors such as mutual funds, insurance companies, and provident funds through a private placement of securities. Companies may also raise funds from the public by making a public issue of bonds where retail investors are called upon to invest.
Bonds of all non-government issuers come under the regulatory purview of SEBI. They have to be compulsorily credit-rated and issued in the demat form. The coupon interest depends on the tenor and credit rating of the bond. Bonds with the highest credit rating of AAA, for example, are considered to have the highest level of safety with respect to repayment of principal and periodic interest. Such bonds tend to pay a lower rate of interest than those that have a lower credit rating such as BBB which are seen as having a high credit or default risk. All public issues of bonds have to be mandatorily listed on a stock exchange. A privately placed bond may also be listed on a stock exchange if it meets the listing requirements.
Corporate bonds can be issued using various cash flow structures. A plain vanilla bond will have a fixed term to maturity with coupon being paid at pre-defined periods and the principal amount being repaid on maturity. The bond is usually issued at its face value, say, Rs.100 and redeemed at par, the same Rs.100. The simple variations to this structure could be a bond issued at a premium or discount to face value or redeemed at a premium or discount to face value. In some cases, the frequency of the interest payment could vary, from monthly, to quarterly and annual. Or, the bonds could feature a cumulative option where the interest is not paid out to the investor periodically but instead re-invested and paid out along with the principal at maturity. The yield to the investor is higher in such an option because of the re-investment returns. Apart from a regular fixed-interest-paying bond, the other types of bonds issued are: zero coupon bonds, floating rate bonds and bonds with put or call options. Convertible bonds, allow investors to convert the bond fully or partly into equity shares, in a pre-determined proportion. Interest earned is fully taxable.
The price of the bonds in the market will respond to changes in interest rates. Secondary market trading in corporate bonds is usually concentrated among institutional investors and the market is not very liquid for retail investors. Apart from credit risk, retail investors also bear liquidity risk while buying these bonds.
Infrastructure Bonds
The government announces from time to time, a list of infrastructure bonds, investment in which is eligible for deduction under Section 80C of the Income Tax Act.
Bonds issued by financial institutions like the Industrial Development Bank of India (IDBI), India Infrastructure Finance Company Ltd. (IIFCL) and National Bank for Agriculture and Rural Development (NABARD) are eligible for such deduction. The bonds are structured and issued by these institutions as interest paying bonds, zero coupon bonds or any other structure they prefer.
The terms of the issue such as tenor, rate of interest and minimum investment may differ across the bonds. What is common is that these bonds have a minimum lock-in period (which could be three years, or five years) during which they cannot be transferred or pledged.
Infrastructure bonds are compulsorily credit rated, and can be issued in the demat form. Interest from these bonds is taxable. Infrastructure bonds do not carry any government guarantee.
Bank Deposits
A bank fixed deposit (FD) is also called as a term or time deposit, as it is a deposit account with a bank for a fixed period of time. It entitles the investor to pre-determined interest payments and return of the deposited sum on maturity. Fixed bank deposits offer higher returns than savings accounts as the money is available for use by the bank for a longer period of time. Fixed deposits are preferred by investors who like the safety that a bank provides and do not have an immediate need for the funds.
Bank FDs are considered to be a safe investment option. This is because each depositor is insured up to Rs.1 lakh by the Deposit Insurance and Credit Guarantee Corporation (DICGC). It includes all deposits and interest on them, held across branches of a given bank.
A fixed deposit is created by opening an FD account with the bank which in turn issues an FD receipt. Interest on an FD can be paid into the depositor’s savings bank account at a predefined frequency, or accumulated and paid at the end of the term. On maturity, the lump sum deposit amount is returned to the investor.
Investors can also choose to renew the deposit on the maturity date. The minimum deposit amount varies across banks. The duration of deposits can range from 7 days to 10 years though FDs longer than 5 years are not very common.
Interest Rates on FDs
Interest rates depend on the duration of deposit, amount deposited and policies of the bank. In general, longer term deposits pay a higher rate than shorter term deposits. Banks also offer special rates to senior citizens, defined as those who are over 60 years of age. Interest rates also vary from bank to bank. The interest rate paid by a bank depends on its need for funds for a particular tenor.
Interest rates do not remain unchanged. Deposit rates offered by banks for various tenors change over time, depending on the economic cycle, their need for funds and demand for credit (loans) from banks. However, a rate committed to be payable for a tenor, until maturity, does not change even if market interest rates change. New rates usually apply only for fresh deposits.
Banks may also prescribe a minimum lock-in period during which funds cannot be withdrawn from the FD account. They may levy a penalty on depositors for pre-mature
withdrawals.
FD holders may enjoy additional benefits such as loan facility against the security of their FD receipts, or cash overdraft facility.
Investment in specified (under Section 80C of the Income Tax Act) 5-year bank FDs are eligible for tax deductions up to a maximum amount of Rs.1 lakh, along with other investment options listed under the same section. These deposits are subject to a lock in period of 5 years and have to be added back to the taxable income in the year of
redemption.
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