G-Secs and T-bills: The Champions of Risk-Free Investing
Government Securities (G-Secs) are nearly two-thirds of the Indian bond market. G-Secs, or gilts, are considered risk-free investments. Get to know them.
Government Securities (G-Secs) and bonds are essentially financial instruments used by governments to raise capital for various projects and activities.
They serve as a means for entities, such as corporations or governments, to borrow money from investors for a defined period, offering fixed or variable interest rates.
G-Secs, specifically issued by the Central Government or State Governments, are considered risk-free gilt-edged instruments.
Let us understand what G-Secs and bonds are, and explore their types, features, and significance in the financial market.
What is a Bond?
A bond is a debt instrument through which investors lend money to an entity, typically a corporation or government. The entity borrows these funds for a specific period and offers a variable or fixed interest rate to the investors.
Bonds are widely used by companies, municipalities, states, and sovereign governments to finance a range of projects and activities.
When individuals own bonds, they become debt holders or creditors of the issuer.
What is a Government Security (G-Sec)?
A Government Security (G-Sec) refers to a tradeable instrument issued by the Central Government or State Governments to acknowledge their debt obligations.
G-Secs can be short-term, such as treasury bills with original maturities of less than one year, or long-term, known as Government bonds or dated securities, with original maturities of one year or more.
In India, the Central Government issues both treasury bills and bonds, while State Governments issue only bonds, also called State Development Loans (SDLs).
These securities are considered risk-free and are often referred to as "gilt-edged" instruments.
Treasury Bills (T-bills)
Treasury bills, also known as T-bills, are short-term debt instruments issued by the Government of India.
They are prevalent in three tenors: 91 days, 182 days, and 364 days.
Unlike regular bonds, T-bills do not pay periodic interest.
Instead, they are issued at a discount to their face value and redeemed at face value upon maturity.
For instance, a 91-day T-bill with a face value of ₹100 may be issued at ₹98.20, offering a discount of ₹1.80.
The return for investors is the difference between the face value (₹100) and the issue price.
Cash Management Bills
In 2010, the Government of India introduced Cash Management Bills (CMBs) in collaboration with the Reserve Bank of India (RBI) to address temporary mismatches in the government's cash flow. CMBs share similarities with T-bills but have shorter maturities of less than 91 days.
Dated G-Secs
Dated G-Secs are securities that carry a fixed or floating coupon (interest rate) paid on the face value in half-yearly instalments.
These securities typically have tenors ranging from 5 years to 40 years. The nomenclature of a dated fixed coupon G-Sec includes the coupon rate, issuer's name, and maturity year.
For example, "7.17% GS 2028" signifies a G-Sec with a coupon rate of 7.17%, issued by the Government of India, with a maturity date of January 8, 2028.
Coupon payments are made half-yearly on July 8 and January 8 each year.
The minimum amount for issue or sale is ₹10,000. In cases where multiple securities have the same coupon and maturity year, a month suffix is added to differentiate them, such as "6.05% GS 2019 FEB" and "6.05% GS 2019 JUN."
Types of Instruments
Fixed Rate Bonds – These bonds have a fixed coupon rate throughout their entire life until maturity. Most Indian Government bonds are issued as fixed-rate bonds.
For example, the "8.24% GS 2018" was issued on April 22, 2008, with a tenor of 10 years, maturing on April 22, 2018. It pays a semi-annual coupon of 4.12% (half of the annual coupon) on October 22 and April 22 each year.
Floating Rate Bonds (FRB) – FRBs do not have a fixed coupon rate but feature a variable coupon rate reset at pre-announced intervals, typically every six months or one year.
India introduced FRBs in September 1995. The coupon rate for an FRB is determined based on the average rate of the last three auctions of 182-day T-Bills.
The coupon rate for subsequent periods is announced as the average rate of the last three auctions of 182-day T-Bills up to the start of each coupon period.
FRBs provide investors with a variable coupon rate, allowing them to potentially benefit from fluctuations in market conditions.
Investors can assess the attractiveness of FRBs by considering both the base rate and the fixed spread, which collectively determine the overall coupon rate.
FRBs offer a unique investment option for individuals and institutions seeking exposure to floating interest rates while maintaining a fixed spread component for stability.
Zero-Coupon Bonds – Zero coupon bonds do not pay periodic interest but are issued at a discount to their face value. The Government of India issued zero coupon bonds in 1996, but they have not been issued since then.
Inflation-Indexed Bonds (IIBs) – IIBs protect both coupon payments and principal amounts against inflation. They are linked to either the Wholesale Price Index (WPI) or the Consumer Price Index (CPI).
In India, IIBs linked to the WPI were introduced in June 2013, and CPI-based IIBs exclusively for retail customers were introduced in December 2013. IIBs were first issued globally in the United Kingdom in 1981.
Bonds with Call/Put Options – Bonds can be issued with call and/or put options, giving the issuer or the investor the right to buy back or sell the bond during its tenure.
For example, the "6.72% GS 2012" issued on July 18, 2002, matured after 10 years on July 18, 2012.
The call option allowed the Government to buy back the bond at face value, while the put option enabled the investor to sell the bond to the Government at face value on any subsequent half-yearly coupon date starting from July 18, 2007.
Special Securities – The Government of India occasionally issues special securities to entities like Oil Marketing Companies such as Indian Oil Corporation Ltd, Fertilizer Companies, and the Food Corporation of India as compensation for cash subsidies.
These securities have slightly higher coupons compared to dated securities with similar maturities.
They are not eligible as Statutory Liquidity Ratio securities but can serve as collateral for market repo transactions.
Bank Recapitalization Bonds were also issued in 2018 to specific Public Sector Banks, known as Special GoI securities.
STRIPS (Separate Trading of Registered Interest and Principal of Securities) – STRIPS are created by separating the cash flows associated with a regular G-Sec into individual securities. These cash flows include semi-annual coupon payments and the final principal payment.
STRIPS are zero coupon bonds created from existing securities and are eligible for SLR. They provide a means to trade individual cash flows separately in the secondary market, allowing for the development of a market-determined zero-coupon yield curve.
Sovereign Gold Bonds (SGB) – SGBs are unique instruments whose prices are linked to the price of gold. They are issued as an alternative to market borrowing and offer investors exposure to gold. SGBs are denominated in grams of gold, with minimum investments of one gram and a maximum limit per fiscal year.
They bear an annual fixed interest rate of 2.5% and can be redeemed after the fifth year. The redemption price is based on the average closing price of gold in the previous three business days.
State Development Loans (SDLs)
State Governments also raise loans from the market through SDLs, which are dated securities issued via auctions similar to those conducted for Central Government securities.
SDLs pay interest semi-annually and repay the principal upon maturity. Similar to Central Government securities, SDLs qualify for SLR and serve as eligible collateral for borrowing and repo transactions.
Vital Role Played by G-Secs
G-Secs constitute nearly 2/3rd of India’s $2 billion bond market, according to various reports.
These debt instruments offer investors risk-free investing opportunities.
However, it is important to note that while G-Secs are considered to be risk-free in terms of credit risk, they are still subject to interest rate risk and market risk.
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