Government Securities(G-Sec)

A Government Security (G-Sec) is a tradable debt instrument issued by the Central or State Governments to raise funds and acknowledge their borrowing obligations. These securities can be classified into two categories: short-term and long-term.

  1. Short-term securities: These are typically called treasury bills (T-bills), with original maturities of less than one year. They are issued at a discount and redeemed at face value upon maturity.

  2. Long-term securities: These are usually known as Government bonds or dated securities, with maturities of one year or more. These bonds pay periodic interest and return the principal upon maturity.

In India, the Central Government issues both treasury bills (T-bills) and Government bonds or dated securities, while the State Governments issue only long-term bonds or dated securities, referred to as State Development Loans (SDLs). These loans help state governments meet their financial needs, and the interest rates on SDLs are typically set by the market, though they tend to be lower than the rates on corporate bonds due to their lower risk.

G-Secs are considered virtually risk-free because they are backed by the Government’s sovereign guarantee. The risk of default is extremely low, making them a highly secure investment. As a result, G-Secs are regarded as gilt-edged instruments, a term that denotes high creditworthiness and security. These characteristics make them an attractive option for conservative investors seeking a safe, low-risk investment.

a. Treasury Bills (T-bills)
T-bills are short-term debt instruments issued by the Government of India, available in three tenors: 91 days, 182 days, and 364 days. They are zero-coupon securities, meaning they are issued at a discount and redeemed at face value. The return to investors is the difference between the issue price and the maturity value. The Reserve Bank of India (RBI) conducts weekly auctions for T-bills, with settlement on T+1 day. A quarterly calendar for T-bill issuances is released by the RBI.

b. Cash Management Bills (CMBs)
Introduced in 2010, CMBs are short-term instruments issued by the Government of India to address temporary cash flow mismatches. They have similar characteristics to T-bills but are issued for maturities of less than 91 days.

c. Dated G-Secs
Dated Government Securities (G-Secs) offer a fixed or floating coupon, paid semi-annually, with tenors ranging from 5 to 40 years. The RBI’s Public Debt Office manages the issuance, interest payments, and redemption of G-Secs. For example, a “7.17% GS 2028” has a 7.17% coupon, issued by the Government of India, maturing on January 8, 2028. Coupons are paid every January and July. If a coupon payment date falls on a holiday, it’s made on the next working day.

d. State Development Loans (SDLs)
State Governments raise funds through SDLs, which are similar to central government securities. These loans are issued via auctions, with interest paid semi-annually and principal repaid at maturity. The RBI manages the public debt of 29 states and one union territory, with market borrowings raised under the Market Borrowing Program. SDL auctions are typically held on Tuesdays.

i) Fixed Rate Bonds
These bonds have a fixed coupon rate for their entire tenure. For example, the 8.24% GS 2018 bond paid semi-annual interest of 4.12% of the face value.

ii) Floating Rate Bonds (FRB)
FRBs have variable coupon rates, adjusted at regular intervals, such as every six months or annually. For example, an FRB issued in 2016 used the average yield of 182-day T-bills for determining its rate.

iii) FRBs with Base Rate and Spread
These bonds have a base rate (e.g., the yield on T-bills) plus a fixed spread determined through an auction. For example, the FRB 2031 bond has a base rate linked to T-bill yields plus a fixed spread.

iv) Zero Coupon Bonds
These bonds are issued at a discount and redeemed at face value, with no periodic coupon payments, similar to T-bills.

v) Capital Indexed Bonds
These bonds protect investors from inflation by linking the principal to an inflation index, ensuring the principal value keeps up with inflation.

vi) Inflation Indexed Bonds (IIBs)
IIBs offer both coupon and principal protection against inflation, using indices like the Wholesale Price Index (WPI) or Consumer Price Index (CPI).

vii) Bonds with Call/Put Options
These bonds offer optionality, allowing the issuer to buy back (call option) or the investor to sell (put option) the bond before maturity.

viii) Special Securities
These are long-dated bonds issued to specific entities like oil or fertilizer companies, often as compensation for subsidies. They carry higher coupons but aren’t eligible for Statutory Liquidity Ratio (SLR).

ix) STRIPS
STRIPS are zero-coupon bonds created by separating the cash flows of a coupon-bearing bond into individual securities, traded independently in the secondary market.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. 

x) Sovereign Gold Bonds (SGBs)
SGBs are gold-linked bonds, denominated in grams of gold. Investors can buy up to 4 kg (individuals) or 20 kg (trusts) per fiscal year. They pay 2.5% annual interest and can be redeemed after 8 years, with early redemption allowed after 5 years. The principal and interest are linked to the price of gold.

  • Safety: Backed by the Government, they offer guaranteed interest and principal repayment.
  • Convenience: Can be held in dematerialized (paperless) form, eliminating safekeeping issues.
  • Flexibility: Available in various maturities, from 91 days to 40 years.
  • Liquidity: Easily sold in the secondary market for cash needs.
  • Collateral: Can be used in the repo market to borrow funds.
  • Attractive Yields: Instruments like SDLs and special securities offer higher returns.
  • Transparency: Active secondary market with readily available price information.
  • Wide Usage: Banks, insurance companies, and smaller investors are also required to hold G-Secs.

G-Sec prices, like those of any traded asset, are subject to fluctuations in the secondary market, driven by the forces of supply and demand. These prices are particularly sensitive to changes in interest rates, overall economic conditions (like inflation and market liquidity), and developments in related markets (money, forex, credit, commodities, and capital). Global bond market trends, especially those of US Treasuries, and policy decisions by the RBI, such as changes to the repo rate or open market operations, also significantly impact G-Sec valuations.

Understanding Risks in “Risk-Free” G-Secs

While Government Securities (G-Secs) are considered low-risk due to government backing, they are not entirely risk-free. It’s crucial for investors to recognize and manage these risks:

1.Market Risk:

  • Fluctuations in interest rates can cause G-Sec prices to change, leading to potential losses if sold before maturity.
  • Holding bonds to maturity can mitigate this risk for small investors.

2.Reinvestment Risk:

  • Coupon payments and principal repayments require reinvestment.
  • If interest rates fall, reinvesting at the same yield may not be possible.

3.Liquidity Risk:

  • Difficulty in buying or selling G-Secs quickly at a fair price.
  • Lack of buyers or low trading volume can lead to losses.

Managing G-Sec Risks:

1.Mitigating Market Risk:

  • Holding G-Secs until maturity.
  • Rebalancing the portfolio, but consider transaction costs.

2.Advanced Risk Management:

  • Using derivatives like Interest Rate Swaps (IRS) to alter cash flows.
  • Requires expertise and careful consideration due to complexity.

In essence, while G-Secs offer high safety, investors should be aware of market, reinvestment, and liquidity risks and employ appropriate strategies to manage them.

While the G-Secs market generally caters to the investors with a long-term investment horizon, the money market provides investment avenues of short term tenor. Money market transactions are generally used for funding the transactions in other markets including G-Secs market and meeting short term liquidity mismatches. By definition, money market is for a maximum tenor of one year. Within the one year, depending upon the tenors, money market is classified into:

  1. Overnight market – The tenor of transactions is one working day.
  2. Notice money market – The tenor of the transactions is from 2 days to 14 days.
  3. Term money market – The tenor of the transactions is from 15 days to one year.

Money market instruments include call money, repos, T-Bills, Cash Management Bills, Commercial Paper (CP), Certificate of Deposit (CD), and Collateralized Borrowing and Lending Obligations (CBLO).

  • Call Money Market: A market for uncollateralized overnight borrowing and lending, open to scheduled commercial banks and primary dealers.

  • Repo Market: A short-term borrowing method where securities are sold with an agreement to repurchase them later at an agreed price, including interest. The RBI regulates this market, and transactions are executed on the Clearcorp Repo Order Matching System (CROMS).

  • Commercial Paper (CP): An unsecured, short-term promissory note issued in dematerialized form, usually by companies, NBFCs, and other entities with a net worth of ₹100 crore or more. CPs are issued at a discount to face value and have no options (call/put). They are issued in minimum denominations of ₹5 lakh.All residents, and non-residents permitted to invest in CPs under Foreign Exchange Management Act (FEMA), 1999 are eligible to invest in CPs.

  • Certificate of Deposit (CD):Certificate of Deposit (CD) is a negotiable money market instrument and issued in dematerialised form or as a Promissory Note, for funds deposited at a bank or other eligible financial institution for a specified time period. Banks can issue CDs for maturities from 7 days to one year.

It can be calculated as per the following formula:

  • T-Bill yield =(100-P)/P x (365/D) x 100
  • wherein, P : Purchase Price and D : Days to maturity
  • Day count for T- Bills :  (Actual number of days to maturity/365)

For example if you want to calculate yield of 91 day T-bill at an issue price of ₹98.10, the yield would be :Yield = (100-98.10)/98.10 x (365/91) x 100 = 7.768%

After say, 30 days, if the same T-Bill is trading at ₹98.80, the yield would be :Yield = (100-98.80)/98.80 x (365/ (91-30) x 100 = 7.267% 

Note that remaining maturity of the T- bill will be (91-30)=61 Days.

One can invest in the following ways:

  • RBI Retail Direct Scheme: This is the primary method for retail investors to directly buy government securities. To invest, an individual need to open a “Retail Direct Gilt (RDG)” account with the Reserve Bank of India (RBI) through their “RBI Retail Direct” platform, allowing them to directly purchase government securities like G-Secs (Government Securities) without a broker. You can invest in various government securities like Treasury Bills (T-Bills), Inflation Indexed Bonds, Floating Rate Bonds, and Sovereign Gold Bonds (SGBs) through this platform.   For creating an RBI Retail Direct account click here : RBI Retail Direct
  • Invest through a stockbroker: Select a stockbroker with access to the government securities market. Access your online trading platform provided by the broker. Navigate to the section for government securities and choose the desired bond then place a buy order. 

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