A critical asset for the DIY investor
(Figure 1)
Governments, like corporates and individuals, raise funds via bonds (or loans). This report covers bonds issued by central and state governments via RBI. Municipal bonds are not covered here.
(For a primer on Government Securities, go here)
About 2 years back RBI enabled individual investors to bid for government bonds directly via the retail channel (link here) and also gave access to secondary markets to buy and/or sell bonds (link here). Access to both sites is fairly easy and there are videos on YouTube that you can view for better understanding. If you have been a DIY investor in the equity space, then this is definitely the right product for you if you want to add fixed income products to your portfolio. Government bonds are, on an average, safer than corporate bonds and buying them directly from RBI website saves you the fees that you would otherwise pay the AMC when buying Gilt (Mutual) Funds. And you have the added advantage of total control over which G-Sec to buy.
Central Government Bonds (CG Bonds)
RBI notifies (via email) about the CG bonds under auction every Monday EOD. At a time, usually 3 bonds are put under auction.
I looked at the coupon rates at issuance for various maturities. For the graph below, in cases of multiple coupon rates, I have taken a simple average. Also, I have not included FY23 since RBI is yet to issue fresh CG bonds for the critical 10-year and 14-year maturities.
(Figure 2)
A few points that stand out
Curve becomes flat in FY 22. For the uninitiated, you want higher interest rate for higher maturities. However, the coupon band from 5 year to 40 year was rather narrow for 2022.
All hikes in interest rate by the RBI last 18 months translated in raising the rates for lower maturities – 5 year bucket.
For FY 23, if we continue to assume that the shape of the curve remains an upward incline, we expect coupon rates for 10-year to fall between those of 7-year and 30-year, that is 7.17% to 7.30%
This was found to be true for all the data points analyzed between FY19 and FY22.
Post issuance, it helps to track tenor-wise indicative yields are here
(Figure 3)
What you pay when you bid for a bond
Let us assume a bid on 7.30 Govt Stock 2053 (Central Government Stock, with a coupon rate of 7.3% and maturity in 2053. From the panel at the top (Figure 1) you see the maturity is on 19 Jun 53. Lets dive in.
Bid Type – NCB – Non Competitive Bid (for retail investors)
Security – name of the bond. 07.30 is the coupon, 2053 is the maturity
Bid Amount – investment amount (minimum bid amount is Rs 10,000)
Clean Price / Yield – They have an inverse relationship. Here the indicative price is less than Rs 100 which implies that the bond is being offered at a discount and the yield (at 7.39%) is thus higher than the coupon rate of 7.30%. For bonds offered at premium (higher than Rs 100), the yield will be lower than the coupon rate. Yield is the return you make on the bond if you hold it to maturity.
Clean Consideration – Rs 10,000 * 98.9/100 = Rs 9,890
Accrued days = 28. This is number of days since the payment of last coupon. CG bonds pay coupon twice a year. For this particular bond, the days would be 19 June and 19 Dec every year till maturity. Accrued days is the number of days since last coupon date and the settlement date which is 17 Jul in this case.
Accrued interest = 28/360 * 10000 * 7.3% = Rs 56.78 (the denominator has 360 days for 1 year – for ease of calculation)
Refundable markup – this is the amount that will be refunded once allocation is done post settlement. I am not sure why this is charged at the time of placing the bid
Indicative Sett Amt = 9890 + 56.78 + 500 = Rs 10,446.78
Indicative Settlement Amount of Rs 10,446.78 is what needs to be paid for every Rs 10,000 you bid. If you get allocation of this bond, the refund of Rs 500 will be credited to your account in a couple of days.
Finally, the question on why you need to pay accrued in3terest. RBI pays interest rate every 6 months for entire 180 days. Since 7.3% coupon is annual rate, you get half of that as interest payment, regardless of when you purchase the coupon. Since in this instance you purchased it 28 days after the coupon payment, you pay it back. On the next coupon payment date, you get interest for the entire 180 day period.
Is now the right time to purchase?
Like all market timing decisions related to equity purchase, this one too is tricky. What complicates the decision is the direction of inflation and economy making it challenging to understand the direction of interest rates. I have been tracking the price and accompanying yields by week and I present here a snapshot from FY23.
(Figure 4)
The bonds highlighted in green have been fresh issuances this year. The other ones are re-issuances.
Cells highlighted in yellow capture the highest price point for that bond (till date). Post that prices across all maturities have been falling. Unfortunately I don't know enough about this world to tell you why.
Recommendation - If you feel waiting is the right thing to do, you may park your funds in the short term T-Bills that RBI makes available for bidding every Friday. These are available in tenures of 90-day, 180-day and 360-day. The returns are much higher than bank deposits. Details in figure 3 above
State Government Bonds (SG Bonds)
On Fridays RBI opens auction for SG bonds along with T-bills. For the period observed, I have seen these usually are issued at par. The coupon rates are better than those offered by CG bonds – the risk is higher in SG bonds.
Assessment of SG bonds
In order to assess which state’s bonds to purchase, you need information on the state’s finances. Periodically, RBI publishes report on the financial health of various states. While detailed, it does help to understand how states are doing so one may make an informed decision on purchasing state government bonds. It is critical that the state doesn’t default on its obligation during the time you hold the bond.
A few graphs in this link give an estimate of the data. The report referred to in the link covers a wide range of items under income and expenditure, including
· Debt and Interest payment - both as % of GSDP (Gross State Domestic Product)
· Composition of revenue and components of own tax
· Revenue spending and quality of expenditure
· Pension outgo
· Subsidy expenditure and growth
In particular, I found the ones below, copied from the site, handy.
(Figure 5)
This figures above show the current Debt to GSDP ratio as well as the direction in which it is moving. I’d look at the change in debt DSDP ratio column and the terminal year outlook closely. The one on the right shows where states stand with respect to the gross fiscal deficit and debt (both as % of GSDP). The lines running through the graph are indicative targets set by the Finance Commission.
(Figure 6)
Recommendation - For the graph above, RBI report covers all states as well as the 5 most indebted states. In all probability, bonds issued by one of these 5 most indebted states come with a higher risk as of now. Since the bonds have long term maturity it may be pointless to speculate how the state’s finances do over the holding period if you hold it till maturity. But these numbers interpreted with other charts may be used as an input to the final investment decision on state selection.
Disclaimer
I hold CG bonds in my portfolio, but no SG Bonds.
Comentarios