What are government securities?

4.8

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The government is tasked with the job of keeping the country running and launching projects to develop various sectors of the economy. It builds and runs hospitals, educational institutions, roads, airports, railways, banks, and other government institutions, among others. This is all common knowledge. 

However, have you ever stopped to wonder - Where does the government get the money to run the country and fund the projects needed for its development? 

One obvious answer is taxes. The taxes you pay in various forms go to the central and state governments, based on the laws in place. And the government bodies use those funds to carry out their functions. Income taxes, GST, import duties - all of this counts. But what happens when the government is in need of additional funds? Well, it simply does what you may do when you need extra funds - it approaches the bank to avail a loan.

In this case, the bank in question is the Reserve Bank of India (RBI). Here’s where things get interesting. The RBI, instead of lending the money directly to the government, auctions the loan out to institutional (and more recently, retail) investors. The loan is auctioned out as government securities (G-Secs). 

So, when you invest in a G-Sec, you are essentially lending the government a little bit of the overall money it intends to borrow. With us so far? Now, if this is the case, you become the lender and the government becomes the borrower. In other words, the government owes you a debt. That’s why G-Secs are called debt instruments. 

And since this is a borrowing, the government owes you interest, which it pays at a predetermined rate periodically, over the tenure for which the debt instrument is valid. At the end of the tenure, your principal (which is the amount that you invested) is returned to you.

That’s the basic principle on which the G-Sec market works. Now that you’ve gotten a fair idea of the fundamentals, let’s take a look at the technical definition of G-Secs.

What are government securities?

Government securities are tradable debt instruments issued by central and state governments. They represent the government’s debt to the investor, who essentially takes on the role of a creditor to the government. These debt instruments are backed by the government. The guarantee that the government gives assures you that the debt will be certainly repaid. This guarantee is known as sovereign guarantee. So, government securities carry virtually zero risk. This makes them one of the safest investment options in the financial market. 

How many types of government securities are there?

Like any sub-asset class, government securities also come in different kinds, depending on things like: 

  • The nature of the borrower (whether it’s the central or the state government) 
  • The tenure of the borrowing (whether it’s short-term or long-term)
  • The nature of the rate at which interest is paid (whether fixed or floating)

Broadly speaking, we have the following four types of government securities in the Indian debt market.

  1. Treasury bills (T-bills)
  2. Cash Management Bills (CMBs)
  3. Dated G-Secs
  4. State Development Loans (SDLs)

Let’s take a closer look at each of these categories to understand government securities better.

What are T-bills?

Treasury bills or T-bills are short-term debt instruments. Here’s everything you need to know about T-bills. 

  • T-bills are issued by the Central Government of India. State governments cannot issue treasury bills.
  • They are issued with three different maturity periods: 
    • 91 days
    • 182 days
    • 364 days
  • T-bills are zero coupon instruments. What does that mean? It means that treasury bills do not pay you any interest. Instead, they are issued at a discount and then, upon maturity, they are redeemed at face value. 

Here’s an example to help you understand how T-bills work. Say there’s a 91-day treasury bill with a face value of Rs. 100. It’s issued to you at a discount of Rs. 2, so you buy it for Rs. 98. At the end of 91 days, your T-bill is redeemed from your demat account automatically by the government at the face value, which is Rs. 100. So, you essentially earn Rs. 2 on the T-bill over the course of 91 days. 

What are Cash Management Bills (CMBs)?

Cash Management Bills are also debt instruments issued to meet the temporary cash flow requirements of the central government. Here’s a quick primer on cash management bills. 

  • CMBs were introduced in the Indian financial markets only recently, in 2010.
  • Just like treasury bills, cash management bills are also zero coupon instruments, so they do not pay any interest to the investor.
  • Instead, they are issued at a discount and redeemed at face value, thereby giving you a positive return on your investment.
  • The key difference between T-bills and CMBs is the tenure. While T-bills have three different tenures (91 days, 182 days and 364 days), as you saw in the previous section, cash management bills mature within 91 days. 

So, they are ultra short-term debt instruments. For the government, they help meet short-term cash requirements. And for you, the investor, they help fulfill short-term goals.

What are dated G-Secs?

Dated G-Secs are long-term debt instruments issued by the government. They can be issued by the central and the state governments, and their maturity periods vary from around 5 years to 30 years or more, depending on the type of dated G-Sec. These instruments are called dated securities because their names contain the date of maturity. 

For example, take the security with the nomenclature as follows:

6.45% GS 2029

Breaking it down, this is what we have.

  • The first part represents the annual interest rate: 6.45%
  • The second part indicates that the instrument is a government security (GS)
  • The third part indicates the maturity year: 2029

G-Secs can be of different types, such as:

  • Fixed Rate Bonds
  • Floating Rate Bonds
  • Capital Indexed Bonds
  • Inflation Indexed Bonds
  • Special securities
  • Bonds with put options or call options 
  • Separate Trading of Registered Interest and Principal of Securities (STRIPS)
  • Sovereign Gold Bonds (SGBs)

Of these, the first two - fixed rate bonds and floating rate bonds - are very common. Let’s look into the details of these dated G-Secs.

What are fixed rate bonds?

Fixed rate bonds, as the name makes it evident, offer interest at a fixed rate throughout the investment tenure, right up to maturity. The interest is paid out half-yearly, and, at the end of the tenure, the principal is returned to the investor.

Here’s an example to help you understand how fixed rate bonds work. Take the same bond we looked at in the previous section - 6.45% GS 2029.

  • This bond was issued on October 7, 2019.
  • It matures on October 7, 2029, after a period of 10 years.
  • The annual rate of interest on this bond is 6.45%.

This means that interest on this security will be paid half-yearly, at the rate of 3.225% (half yearly payment being half the annual interest rate of 6.45%). The interest will be paid on the face value each year, on April 7 and October 7, till 2029. 

What are floating rate bonds?

Unlike fixed rate bonds, floating rate bonds do not come with a fixed rate of interest. The interest rate is variable, and it is reset at predetermined intervals such as every six months or each year. This continues right up to maturity. The upside of investing in floating rate bonds is that the interest tends to go up when the economic and market conditions are good, so you can benefit from this development.

What are State Development Loans (SDLs)?

Much like the central government, state governments also require additional funds from time-to-time to carry out their developmental activities. And to meet these requirements, they also issue debt instruments in the form of SDLs or State Development Loans. Here are the key details about SDLs.

  • They are issued only by the state governments in India. 
  • SDLs help fund the activities of the state governments and satisfy their budgetary needs. 
  • Similar to dated G-Secs, SDLs also pay interest half-yearly. 
  • They come in a wide range of investment tenures. 

Wrapping up

This should give you a fair idea of how the government securities market in India works. But do keep in mind that government securities only make up one segment of the debt market. What are the other instruments in the debt segment? Curious about that? Head to the next chapter to find out more about corporate bonds, which are among the many debt instruments in the Indian market.

A quick recap

  • Government securities are tradable debt instruments issued by central and state governments. 
  • They represent the government’s debt to the investor, who essentially takes on the role of a creditor to the government. 
  • The sovereign guarantee on these instruments make them one of the safest investment options in the country.
  • There are 4 main kinds of government securities: T-bills , Cash Management Bills, dated G-Secs and State Development Loans.
  • Treasury bills or T-bills are short-term debt instruments.T-bills are issued by the Central Government of India. 
  • They are issued with three different maturity periods: 91 days, 182 days and 364 days.
  • Treasury bills do not pay you any interest. Instead, they are issued at a discount and then, upon maturity, they are redeemed at face value. 
  • Cash Management Bills are also debt instruments issued to meet the temporary cash flow requirements of the central government. 
  • The key difference between T-bills and CMBs is the tenure. While T-bills have three different tenures (91 days, 182 days and 364 days), as you saw in the previous section, cash management bills mature within 91 days. 
  • Dated G-Secs are long-term debt instruments issued by the government. They can be issued by the central and the state governments, and their maturity periods vary from around 5 years to 30 years or more.
  • Fixed rate bonds - a type of dated G-Sec, offer interest at a fixed rate throughout the investment tenure, right up to maturity. The interest is paid out half-yearly, and, at the end of the tenure, the principal is returned to the investor.
  • Unlike fixed rate bonds, floating rate bonds do not come with a fixed rate of interest. The interest rate is variable.
  • SDLs or State Development Loans are debt instruments issued by state governments.
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