Pillars of retail G-Sec market

In the Union Budget for FY 2021-22, the government proposed to consolidate various statutory Acts, namely the Securities Exchange Board of India (SEBI) Act, 1992, and the Government Securities Act 2007, etc. into a rationalised single securities markets code.

Consequently, the Reserve Bank of India (RBI) allowed retail investors to participate in the government securities (G-Sec) market — both primary and secondary — through ‘Retail Direct’, an online portal for trading.

This is a key structural reform since India is only the third country, after the US and Brazil, in enacting such a provision. Though, the RBI has been allowing small investors to participate in G-Sec market since 2001, it has not gained significant traction and is mostly confined to institutional investors as it is a high-volume game and specialised in nature.

Through the proposed initiative, the RBI is going to auction long-term dated securities: G-Secs, State Development Loans (SDLs), and short-term instruments: Treasury Bills (TBs) to retail investors.

The main objectives of the government are: (i) to provide retail investors another digital avenue for their financial savings; (ii) to meet its mammoth borrowing programme of ₹12 lakh crore in order to bridge its burgeoning fiscal deficit, and (iii) to broaden and deepen the investors’ base for better price discovery in the G-Sec market.

In view of the above background, let’s understand what are the main pillars of retail G-Sec market to make it vibrant.

Return on investment

Investors generally evaluate different investment options based on safety, liquidity, and ‘yield to maturity’. Yields on G-Secs are a function of inflation, government borrowings, liquidity and volatility in the international markets, crude oil prices, and overall risk sentiment.

While G-Secs/SDLs usually fare better in terms of safety, and offer higher yields than fixed deposits (FDs) in banks, they provide lower after-tax returns compared to other small savings instruments such as deposits in post office, public provident fund (PPF), Sukanya Samruddhi Yojna, AAA rated bonds issued by Central Public Sector Undertakings, etc.

Therefore, the government needs to suitably compensate the retail investors, including senior citizens, by issuing tax-free bonds/price discounts and the like. Being the banking regulator, the RBI may refrain from controlling interest rates and leave the same to the market forces to avoid any devolvement of G-Sec auctions on primary dealers (PDs) as witnessed in the recent past.

Liquidity

Though the G-Sec market witnessed significant improvement in terms of liquidity, transparency and risk management after introduction of delivery versus payment system since 2001, trading is mainly concentrated in a few securities.

While 10-year benchmark government papers have ample liquidity in the market, other dated securities, and SDLs are not that liquid. While retail investors may find it easy to invest in G-Secs in the primary market, it may not be that easy to sell (before maturity) in the secondary market since these securities need to be liquidated at prevailing market prices.

Here, the investors are likely to lose, if the current market interest rate is higher than the coupon rate of the dated securities and vice versa (interest rate risk). One possible solution for this is to broaden and deepen the market and incentivising investors to hold the securities till maturity. The RBI can open a Repo window for retail investors to enable them to mobilise funds on their G-Secs. Banks/PDs may be authorised to act as market makers to provide sufficient liquidity to the retail investors in the secondary market.

Ease of investing

Investors prefer investments which gives them seamless, interoperable, and personalised high-end experience. Though total lock-in period for PPF is 15 years, investors still prefer to invest in it as it can be digitally linked to their savings bank account apart from yielding higher return and providing tax exemption.

To enable ease of investing, reduce operational risk, and achieve transactional efficiency, the proposed Retail-Direct should be linked to the retail investors’ demat/Subsidiary General Ledger (SGL) account for straight through processing. Further, the RBI may look at offering small market lots of ₹1,000 (instead of ₹10,000) to bolster retail participation.

Robust infrastructure

Digital financial inclusion can be a reality when the proposed G-Secs are made accessible to all eligible investors, including foreign investors, through 24X7 network and state-of-the-art clearing and settlement procedures.

The US has a thriving government bond market through its Treasury Direct from the Federal Reserve, is a case in point.

Recent outage in online digital services of HDFC Bank highlighted the need for robust trading infrastructure, cyber security and customer protection to build confidence among the retail investors and enhance usage of Retail-Direct.

Financial and digital literacy

As public awareness about G-Secs/SDLs is relatively lower, Retail-Direct will be successful when financial and digital literacy are imparted in simple, clear and Indian languages. 76 per cent of adults in India do not even understand the basic financial concepts like interest rate, inflation, yield to maturity, etc (Standard & Poor’s, 2015). Though some of the people are financially literate, they are not necessarily digitally savvy.

Indians simply love gold (physical as well as financial); perhaps this is the primary reason behind the reasonable success of Sovereign Gold Bonds which rekindled the hopes of RBI as it has been entrusted with unenviable task of management of public debt and anchoring inflationary expectations.

However, it is naive to expect similar success in Retail-Direct too, without providing a conducive environment.

As ‘timing’ is the key for securing higher returns on G-Secs, current benign interest rate regime poses considerable challenges to the retail investors (low real returns).

It is hoped that Retail-Direct will be investor-friendly unlike floating rate savings bonds from the RBI. The scheme may be successful, given the proposed privatisation of Indian public sector banks which offer lower yields on FDs and widespread adoption of digital financial services by the public, thanks to demonetisation and Covid-19.

Srikanth is with DDU-GKY and National Institute of Rural Development and Panchayati Raj, Hyderabad.Prabu is Assistant General Manager, International Banking, SBI, Chennai. Views expressed are personal

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