Last Updated on September 18, 2023 by BFSLTeam BFSLTeam
Debt instruments like bonds are generally considered to be safe investment options. However, even within this asset class, some instruments are safer to invest in than others. Government bonds, for instance, carry the lowest possible risk among all the securities issued and traded in the bond market.
Whether you are an aggressive, moderate or conservative investor, government bonds in India can be beneficial for you. If you are risk-averse or prefer only moderately risky instruments, these bonds, with their negligible risk, are suitable options. On the other hand, if you take on more investment risks, you can reduce your overall risk exposure associated with government bonds.
Whatever your reason for choosing these instruments may be, it’s crucial to first familiarise yourself with the meaning of government bonds, their variants and their risk profile. We’ll cover all these aspects in this article.
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What are Government Bonds in India?
A government bond is a debt instrument that has been issued by the central government or any of the state governments in India. These governments may be faced with the need to raise capital to fund infrastructure and other development projects from time to time. Issuing bonds is one way to gather the funds needed.
Government bonds in India are, in essence, loans offered by investors to the government. Since these instruments have the backing of the government’s guarantee, they are considered to carry little to no risk of default.
How Do Government Bonds Work?
So, now that we’ve discussed what government bonds are, let’s delve into how they typically work.
When you invest in a government bond, you are essentially lending that money to the government that issued the instrument. In return for this loan, the government will pay you interest at regular intervals in the form of annual (or semi-annual) coupon payments. The rate of these interest payments, known as the coupon rate, is generally fixed upfront.
Government bonds in India also come with predetermined maturity periods. This duration can be as long as 20 years or more. Over this entire period, the government will continue to pay interest at the coupon rate applicable. Thereafter, on the maturity date, the government repays the principal or the face value of the bond to you. This concludes the cash flows from the bond, and you will no longer receive the annual coupon payments.
Considering that these securities offer fixed income, you can invest in government bonds in India if you want to set up an alternate source of income. You can even use it as an investment option to replace your primary income to a certain extent when you retire.
Types of Government Bonds in India
If you are planning on investing in government bonds, you can choose from different types of securities in this category. The most common options include the following.
Fixed Rate Bonds
In case you want to keep your investment risk to a minimum and require absolute certainty, fixed rate government bonds may be suitable for you. These government bonds carry a fixed and predetermined coupon rate that remains constant during the bond’s lifetime.
For example, if you purchase bonds like the 7.18% Government Securities 2037, it means you will receive interest at 7.18% per annum till the maturity date in 2037. The main advantage of these types of government bonds in India is that you know exactly how much you can earn right at the time of purchase.
Additional Read: Sovereign Gold Bond
Floating Rate Bonds
Unlike fixed rate bonds, floating rate bonds (FRBs) issued by the government carry variable rates of interest. The frequency at which the rates will be revised is generally fixed upfront. The coupon rates on these government bonds in India may be linked to a benchmark rate. And when that benchmark fluctuates, the coupon rate will be changed accordingly.
In some floating rate bonds, the coupon rate has two components — a base rate and a predefined spread over and above this baseline. The spread is fixed, but as the base rate changes, the overall coupon rate also increases or decreases accordingly.
Inflation-Indexed Bonds
These government bonds in India are linked to inflation indices like the Consumer Price Index (CPI) or Wholesale Price Index (WPI). The coupon rate on these securities changes as inflation increases. This acts as a hedge and protects you from the decreasing value of money over time.
Sovereign Gold Bonds
Sovereign Gold Bonds (SGBs) are government bonds in India that are linked to physical gold. These securities are denominated in ‘grams’ of the precious metal, and they can be an excellent substitute if you do not want the burden of owning physical gold.
The minimum amount of investment in SGBs in terms of the denominations is one gram, while the maximum limit is 4 kilograms. The nominal value of these bonds is determined based on the simple average of the closing prices of the precious metal over the last 3 business days in the week before the subscription.
Do Government Bonds Carry Any Risks?
While you may be exposed to little or no risk of default if you are investing in government bonds, there are other kinds of risk that you should be prepared for. They include the following:
- Inflation risk: The possibility that your bond will decrease in value due to rising inflation
- Interest rate risk: The possibility that the bond value could decrease due to rising interest rates
- Currency risk: The possibility of your investment value eroding due to changing currency rates (applicable only if you buy government bonds that pay interest in different currencies)
Conclusion
Whether you are risk-averse, comfortable with taking on investment risks, or somewhere in between, government bonds in India can find a place in your portfolio for different reasons. So, it is always a good idea to monitor announcements for new issues. You can then check whether the bonds that any government plans to issue may be a good fit in your overall financial plan. Depending on this, you can decide whether or not you wish to invest in the new issue.
