You can minimize investment risks and earn a stable income by investing in government bonds. In India, government bonds are one of the safest investment options because they are issued by the government and the risk of default are low.
What is Government Bond
A government bond is a debt security issued by the central and state governments of India to raise money for financing its fiscal deficit and other developmental activities.
When you invest in a government bond, you are essentially lending money to the government in exchange for regular interest payments and the repayment of the principal amount at a predetermined maturity date.
The interest rate offered on government bonds depends on the creditworthiness of the government, the prevailing interest rates, and the maturity period of the bond.
How Government Bonds Work in India
The government borrows money from investors by issuing bonds, and in return, pays interest on the borrowed amount. The interest payments are made periodically, such as annually, half-yearly, or quarterly, depending on the type of bond.
The government issues different types of bonds to meet its various funding requirements. Bonds have a maturity period from 1 year to 40 years. The interest rate on government bonds depends on various factors, such as prevailing market conditions, inflation expectations, and credit ratings.
In India, government bonds are traded in the bond market, which is an over-the-counter (OTC) market, where transactions take place between buyers and sellers directly or through brokers.
You can purchase government bonds in two ways –
- Primary market
- Secondary market
In the primary market, government bonds are issued for the first time and are sold directly to you through auctions conducted by the RBI or the government.
In the secondary market, you trade in government bonds and the price of the bond is influenced by the demand and supply in the market.
When interest rates increase, the price of the bond tends to decrease. Similarly, if there is a rise in inflation expectations, the price of the bond falls.
Benefits of Investing in Government Bonds
Government bonds offer several benefits, such as:
- Low Risk: Government bonds are considered one of the safest investment options because they are issued by the government, and the chances of default are low.
- Fixed Income: Government bonds offer a fixed rate of interest, which provides a stable income.
- Diversification: Investing in government bonds diversifies your investment portfolio, which helps in reducing risk.
- Liquidity: You can easily buy and sell government bonds in the secondary market, which provides liquidity to you.
Who Should Invest in Government Bonds
Government bonds are an ideal investment option for you who are looking for low-risk investments that provide a regular source of income.
However, you should carefully analyze the risks and returns of government bonds before investing based on your financial goals and risk appetite.
Different Types of Government Bonds in India
#1. Treasury Bills (T-Bills)
T-Bills are short-term debt instruments with a maturity period of less than one year. T-Bills are issued at a discount to the face value and redeemed at face value on maturity. T-Bills are available in three maturities – 91 days, 182 days, and 364 days.
#2. State Development Loans (SDLs)
SDLs are issued by state governments to finance their development activities. They are long-term debt instruments with a maturity period of more than one year. SDLs come with different maturities ranging from 10 years to 15 years.
#3. Sovereign Gold Bonds (SGBs)
SGBs are issued by the government to provide an alternative to holding physical gold. These bonds are denominated in grams of gold and offer an annual interest rate of 2.5%. SGBs have a maturity period of 8 years, and you can redeem them after the fifth year.
You may also like to read how to invest in Sovereign Gold Bonds.
#4. Inflation-Indexed Bonds (IIBs)
Inflation-indexed bonds issued by the Reserve Bank of India that provide protection against inflation. The principal amount and interest payments on IIBs are adjusted for inflation using the Wholesale Price Index (WPI) or Consumer Price Index (CPI).
They offer a fixed rate of return and bonds are issued for a tenure of 10 years. IIBs protect you from the erosion of purchasing power caused by inflation.
#5. Cash Management Bills (CMBs)
CMBs are short-term debt instruments with a maturity period of less than 91 days. They are issued by the government to meet its short-term funding requirements.
#6. 7.75% GOI Savings Bond
7.75% GOI Savings Bonds are non-tradeable bonds that offer a fixed rate of interest of 7.75% per annum. These bonds have a tenure of 7 years and can be held in dematerialized or physical form.
#7. Zero-Coupon Bonds
Zero-Coupon Bonds are bonds that do not pay interest but are issued at a discount to the face value. You can earn a profit when the bond is redeemed at face value on maturity.
#8. Floating Rate Bonds
Floating Rate Bonds issued by the Indian government where the interest rate is not fixed but fluctuates with changes in the market interest rates. The interest rate on floating rate bonds is typically linked to a benchmark rate, such as the Mumbai Inter-Bank Offer Rate (MIBOR) or the Government of India Treasury Bill rate.
The interest payments on floating rate bonds are made periodically, and are calculated based on the prevailing market interest rates at the time of payment.
#9. Fixed-Rate Bonds
Fixed-rate Bonds are bonds that offer a fixed rate of interest throughout the tenure of the bond.
5 Ways to Invest in Government Bonds
There are several ways to invest in government bonds in India, including:
#1. RBI Retail Direct
RBI Retail Direct is an online platform launched by the Reserve Bank of India (RBI) in 2020, which allows you to invest in government securities directly. You need to register a Direct Gilt Account with the RBI to invest through RBI Retail Direct.
The platform offers a simple and hassle-free way to invest in government bonds and eliminates the need for intermediaries such as brokers or agents.
To open an account, you need to complete your KYC process by providing your PAN card, bank account details, and a valid mobile number linked with your Aadhar card. Once your account is opened, you can start investing in government securities through the platform.
RDG offers four types of government bonds that you can invest in:
- Dated Government Securities (Dated G-Secs)
- State Development Loans (SDLs)
- Government of India Treasury Bills (T-Bills)
- Sovereign Gold Bond (SGB)
The minimum investment amount for retail investors for SDLs, T-Bills, and Dated G-Secs is Rs. 10,000. For SGB, the minimum investment is 1 gram of gold.
#2. Gilt Mutual Funds (MFs)
Gilt mutual funds offer a convenient way for you to invest in government bonds. These are debt mutual funds that primarily invest in government bonds, including T-bills, G-Secs, and SDLs, and fixed-income securities.
You can invest in GILT mutual funds through a lump sum investment or SIP (Systematic Investment Plan). However, like other mutual funds, there is an expense ratio involved.
Fund houses charge a fee to manage your investment in these schemes. For gilt mutual funds, the upper limit for the expense ratio is 2.25%. It is important to compare the expense ratios of top gilt schemes before investing to generate higher returns.
You may also like to read our article on how to invest in mutual funds in Zerodha along with government bond investment.
#3. Exchange-Traded Funds (ETFs)
ETFs are like mutual funds, but they are traded on the stock exchange like shares. Government bond ETFs invest in a basket of government bonds and offer you the flexibility to buy and sell units like shares.
#4. Banks and Post Offices
You can also invest in government bonds through banks and post offices.These institutions act as intermediaries and sell government bonds on behalf of the government.
To buy a government bond from a bank or post office, you can follow these steps:
- Visit the nearest bank or post office and carry all necessary documents such as Aadhaar card, PAN card, address proof, and Demat account number.
- Fill out the application form provided by the bank or post office.
- Submit the completed application form along with the required documents.
- The bank or post office will then process the request and issue a bond certificate in the investor’s name.
#5. Invest in Government Bonds Through Stockbrokers
You can also invest in government bonds through stockbrokers like Zerodha, Groww, and Upstox. However, before investing in government bonds, you need to open a demat account.
Let’s take an example of Zerodha to invest in government bonds. Follow these steps:
How to Invest in Government Bonds Through Zerodha Coin Web
Step #1. Login to Zerodha Coin using your credentials. You can open a Zerodha demat account if you don’t have a demat account.
Step #2. Click on “Government bond” on the dashboard.
Step #3. Choose the type of government bond to invest in, such as T-Bills, GOI-Dated Bonds, or SDLs.
Step #4. Click on “Place Order” against the required government bonds.
Step #5. Enter or click on the units under “Units to buy.”
Step #6. Click on “Confirm.”
It is important to note that the minimum investment amount in G-Secs is Rs. 10,000 and the maximum is Rs. 2 crores. You should ensure that you have sufficient funds in your Zerodha account on the bid closing date.
Bond yield refers to the rate of return or the interest earned on a bond investment. It is expressed as a percentage of the bond’s face value or the price at which the bond was initially issued.
Yes, government bonds can be sold before maturity in the secondary market. However, the price at which the bonds can be sold may be lower or higher than the face value, depending on the prevailing market conditions.
Yes, NRIs can invest in government bonds in India through the RBI’s Liberalized Remittance Scheme (LRS).
The interest income earned from government bonds is considered income from other sources and taxable as per your income tax slab.
Additionally, the appreciation in bond prices is considered capital gains. The long term capital gains (LTCG) is 10% flat and the short term capital gains (STCG) as per your income tax slab rate.
However, there is no Tax-deducted-at-source (TDS) for the interest payments received for government bonds.
Although government bonds are considered low risk, there are some risks associated with investing in government bonds in India. Some of the risks are:
- Interest rate risk: The value of bonds may fall if interest rates rise.
- Inflation risk: The returns on bonds may be reduced if inflation rises.
- Liquidity risk: Government bonds may not be easily tradable in the market.
- Credit risk: Although the chance of default is low, there is still a risk that the government may default on its bonds.
The minimum investment required for government bonds in India is Rs. 10,000. However, the amount may vary depending on the type of bond and the issuer.