The RBI has stood rock-solid behind the Centre through the pandemic supporting all the efforts to rescue the economy, be it in supplying funds to distressed sectors, slashing interest rates or supporting the expanded government borrowing while keeping the 10-year government bond yield below 6 per cent through last year. But the mettle of the central bank will be severely tested in the months ahead with the Centre intending to borrow an additional ₹80,000 crore in FY21 and follow it up with another ₹12.05-lakh crore in FY22.
What’s more, bond markets have to deal with expanded borrowing over the next five years, at least, as indicated by the fiscal glide path. It’s not surprising that the bond market is beginning to throw tantrums, with 10-year bond yield spiking to 6.15 last week as two bond auctions devolved on primary dealers.
While the RBI’s announcement of open market operations has assuaged sentiment somewhat, it is clear that there is a dire need to find a new set of investors to absorb the excessive supply of government papers that are set to flood the market over the next year.
The RBI Governor’s announcement of making the government bond market more accessible to the aam aadmi needs to be seen against this background. There is no doubt that the individual investor, especially the HNI, is looking for avenues to invest, as seen in the voracious appetite for primary equity issuances or the surging trading turnover in stocks.
But attracting retail investors to G-Sec market may not be that easy.
The Governor announced in its latest Monetary Policy that retail investors will be provided direct online access to the government securities market — both primary and secondary — through a Retail Direct platform, to be launched shortly. They can also open gilt securities account with the RBI. The details of the Retail Direct platform are yet to be made public, but it is a step forward in giving individual investors easier access to government bonds and treasury securities.
The RBI has been allowing retail investors to test the waters for some time now. They had been allowed to participate in the primary market for G-Secs through banks or primary dealers by making non-competitive bids. But they were allotted securities at prices discovered through the competitive bidding in which only large institutional investors participated. The complexity of this route was also a deterrent. Retail investors can also bid in the primary market for bonds through aggregators such as the NSE or the BSE that consolidate all the bids and participate in auctions. Investors can place bids through their brokers and receive the G- Secs in their demat accounts; the securities can also be sold on exchanges. But the trading volume on exchanges is very thin making it difficult for investors to exit.
Why the disenchantment?
In short, avenues already exist for retail investors to buy gilt securities in auctions. But they are not showing much interest due to three main reasons.
One, individual investors find it easier to understand and trade in stocks than bonds and exchange traded fixed income instruments. Small investors have typically found the pricing of bonds, the yield to maturity calculation and the drivers of the bond market far more difficult to understand.
This is highlighted in the retail holding in mutual funds. While retail investors hold just 38 per cent of debt mutual funds, they hold a far higher 89 per cent in equity-oriented funds. Overall interest in gilt securities is quite low, as reflected in the assets managed by gilt funds amounting to just ₹20,139 crore, less than one per cent of the total mutual fund AUM of ₹30-lakh crore.
Two, pre-tax returns on gilt, at around 6 per cent, is far from attractive when compared to interest on other sovereign savings instruments such as PPF, Kisan Vikas Patra and National Saving Certificate or even the RBI floating rate savings bond. Many of these other instruments also enjoy tax incentives that boost their effective returns.
Three, Indian households are conservative in their investments, with a leaning towards physical assets. According to the RBI, the average Indian household holds 84 per cent of its wealth in real estate and other physical goods, 11 per cent is invested in gold and only 5 per cent in financial assets. Of the financial assets, over 56 per cent is in bank deposits. Hence, making the typical Indian invest in government bonds will not be easy.
Attracting retail participation
Other countries have also tried to allow retail participants in the government bond market, but have not met with great success. The US’ Treasury Direct platform allows retail investors to buy and redeem treasury securities directly. But, according to SBI Ecowrap, the turnover on this platform is less than one per cent of the overall trading in US government securities. Japan and Brazil, too, have tried issuing bonds to individual investors directly.
Most countries have, however, tried to attract retail investors to government securities through gilt mutual funds.
That appears to be a better way for the Centre, since the fund managers are better equipped to understand the interest rate risks and manage the duration of the securities in the portfolio to get optimum gains. It is also more tax efficient for investors to park money in gilt mutual funds, where gains made after three years are taxed at 20 per cent after indexation.
If the Centre wants to increase retail participation in G-Secs in a big way, it needs to announce some tax breaks for individual investors buying G-Secs, at least for 3-5 years. A new scheme on the lines of Rajeev Gandhi Equity Savings Scheme for a limited period can work here, as there are far fewer retail investors in gilt securities when compared to equities. Tax breaks can be given to retail investors investing in gilt funds too.
Gilt securities are superior to other savings instruments in that they allow investors to lock in to an interest rate for really long-term — 20-30 years.
There is no interest rate risk if the securities are held to maturity and can serve as a good retirement saving vehicles.
But the RBI should ensure that investors understand these instruments well and an awareness drive towards this end may help.
The risk of capital loss, if the securities are sold before maturity, should be communicated clearly.