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RBI Has Allowed Indians To Directly Invest In Bonds. Should You Invest? Since retail investors were previously prohibited from directly investing in G-secs, it has been hailed as one of the pivotal decisions taken by the RBI

By Abhinav Angirish

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Due to the introduction of the "RBI Retail Direct Programme," Indian citizens can now register accounts with the Reserve Bank of India and make direct investments in government securities (G-secs). On November 12, 2021, Prime Minister Narendra Modi unveiled the program to the public. Since retail investors were previously prohibited from directly investing in G-secs, it has been hailed as one of the pivotal decisions taken by the RBI.

G-secs are guaranteed by the central government, which means they do not have any credit risk but they do involve interest risk. Consequently, if you want to successfully invest in government securities, you need to pay attention to the interest rate cycle and the maturity of the government securities. For illustration's sake, say you own a long-term bond paying 7% interest; if that rate were to increase to 8%, the value of your bond would decrease. A bond's price is more sensitive to changes in interest rates the longer its tenure.

Long-term debt instruments like G-Secs are susceptible to interest rate fluctuations, making them a risky investment option. So, it's important for investors to have a solid grasp of the current interest rate and its future trajectory. The danger of interest increases with increasing maturity. Individual investors who choose to invest in G-Sec on their own should proceed with caution. Some would argue that debt funds who invest in G-Secs are risky proposition. While it is true that the interest rate risk is still present in debt funds, but it is mitigated by the professional judgment of the fund managers who assemble the portfolio.

However, experts argue that the major negative of investing through direct platform has been the limited secondary market liquidity in retail lots. As of now, gilt mutual funds are the most convenient way for individual investors to purchase treasury instruments,

In order to qualify as a "Gilt fund," a debt mutual fund must have at least 80% of its assets invested in government securities. Due to the sensitivity of these schemes to changes in interest rates, timing is of the essence for both entry and withdrawal. At a period of declining interest rates, bond prices tend to rise, making these strategies quite effective. During the course of the past year, gilt funds delivered an annualized return of 5.88%- 6.15% in three year period.

How G-Secs compare to small savings programs

The current annual return offered by PPF is 7.1% and is completely tax-free. Five-year National Savings Certificates also accrue interest at 7% percent per year, but only pay out the full amount at the end of the term. The current yield on a 10-year Government of India (GOI) bond is at 7.39 percent, while the yield on a 3-year GOI bond is around 7.29 percent. The greater interest rate definitely tips the balance in favour of more manageable savings strategies.

Regular interest is distributed on all retail-market government bonds. There is no option for cumulation. Hence, once interest is received, it is added to your normal income and is taxed annually at your applicable income tax slab rate. Those who invest in simple debt funds (such gilt funds, which invest solely in government debt) can defer paying taxes on their gains until they sell their investment, and investors who retain their funds for three years or more can benefit from indexation on their returns and pay a lower rate of taxation. As a result, the debt funds significantly lower your tax outlay. The compounding of coupon interest in a mutual fund boosts the value of the investment over time, which in turn boosts returns. Your returns will therefore be lower due to unfavourable taxes since there are no tax advantages to invest through the platform.

The critical term in this context is "retail." It doesn't add much value to a financial portfolio, especially if you're a modest retail investor. Besides a select few types of debt funds and Target Maturity Funds, traditional choices like EPFs, PPFs, SCSS, and the Pradhan Mantri Vaya Vandana Yojana make it easy to manage your debt portfolio. Even though G-Secs don't expose investors to any credit risk, these other options all provide higher after-tax yields. To better accommodate your cash flow needs, you can use a combination of these instruments to construct a maturity ladder.

The Reserve Bank of India's Retail Direct service is an excellent program. However, this could take more time to become commonplace because bond markets in India are still relatively new and only a small fraction of the general public understands how they work. With the present amount of activity on the platform, the government may be considering new strategies to bring in individual investors. It might make sense to provide tax breaks, at least analogous to what debt funds offer.

Abhinav Angirish

Founder, Investonline.in

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