Floating Rate Savings Bonds, 2020 – Attractive rate, maximum safety

BL Research Bureau

About a month back, on May 28, 2020, subscription to the 7.75% Government of India (GOI) taxable bonds, also popularly known as 7.75% RBI bonds, was stopped. This caused quite a bit of angst among conservative investors, and understandably so. The bond was among the last bastions of relatively high returns (7.75%) in a rapidly falling interest rate environment, and it had maximum safety too, thanks to the government guarantee.

Thankfully, the government has now announced the launch of a similar scheme – Floating Rate Savings Bonds, 2020 (Taxable), commencing from July 1, 2020. This will come as a relief to those seeking very safe investment options with relatively high returns. The annual rate of interest on these new bonds – also known as FRSB 2020 (T) - will be 7.15 per cent, to begin with.

Differences, similarities

But as the name suggests, the interest rate on the FRSB (2020) is a floating one, and it will be reset every six months. So, the rate of 7.15 per cent will be applicable from July 1, 2020 to December 2020, and will be reset on January 1, 2021; after that, it will be changed every six months on July 1 and January 1. This is a key difference compared with the earlier 7.75% GOI bonds, in which the rate at the time of investment (7.75 per cent) stayed till maturity.

Another key difference is that in the new bonds, the interest will necessarily be paid out every six months – on January 1 and July 1 every year. There is no cumulative option in the new scheme, unlike the earlier 7.75% GOI bonds which came with both cumulative and non-cumulative (half-yearly interest payment) options.

But there are some similarities too with the old scheme. The tenure of the bonds, for instance, is the same as the earlier bonds - seven years, at the end of which the bonds shall be repaid. The interest on the bonds is taxable, similar to the previous bonds. Besides, like before, there is no maximum limit on the amount that can be invested in the bonds. Also, the bonds are not tradable in the secondary market or transferable, and shall not eligible as collateral for loans. So, an investor is locked in with the investment for 7 years. Premature redemption shall be allowed for specified categories of senior citizens though, after specified periods; the penalty for premature withdrawal is 50 per cent of the interest due and payable for the last six months of the holding period.

Rate reset mechanism

The half-yearly interest rate reset on the bond will be linked to the prevailing rate on the NSC (National Savings Certificate) with a spread of 35 basis points (bps) over the respective NSC rate. One basis point is 1/100th of a percentage point; so 35 bps is 0.35 percentage points. Currently, the interest rate on the NSC is 6.8 per cent, and so the rate on the FRSB (2020) bond has been fixed at 7.15 per cent (6.8 + 0.35) for the July 1 to December 31, 2020 period; interest at 7.15 per cent will be paid on January 1, 2021.

The subsequent interest rate resets will be based on the rate of the prevailing NSC rate on January 1 and July 1 each year. So, as the interest rate on the NSC changes, the rate on the FRSB (2020) bond will also change every half-year. The NSC rate itself is linked to the G-Sec yield and subject to change every quarter. It could increase or decrease, depending on the interest rate trajectory in the economy. In the current scenario, when rates seem headed lower, the NSC rate and thus the FRSB (2020) bond rate could also decline in the next rate reset. But this is not a given, given the many uncertainties, and rates could stay where they are or even head higher.

Good rate

The interest rate being offered on the FRSB (2020) bonds seems attractive. One, rates across the spectrum have fallen sharply over the past year or so, and most banks now offer an average of 5.5 – 6 per cent even on long-term deposits. Only a few private sector banks and small finance banks offer better rates – 7.25 to 7.5 per cent. In this context, the 7.15 per cent currently being offered on the FRSB (2020) bond seems a good deal, especially given its maximum safety quotient. Bank deposits are insured up to Rs 5 lakh a bank across branches, while the entire amount invested in the FRSB (2020) bond has the maximum safety.

Next, with the interest rate on the bond being pegged 35 bps over the NSC, the FRSB (2020) should continue to have an edge throughout the investment period. The interest rate on the bond should likely remain relatively attractive compared with most other options through rate up-cycles and down-cycles.

Who can invest & how?

Individuals (singly or jointly) and Hindu Undivided Families (HUFs) can invest in the FRSB 2020 (T) bond. Only a person resident in India can invest in the bond; NRIs are not eligible.

The minimum investment amount is Rs 1,000 and in multiples thereof. The subscription the bond can be in the form of cash (up to Rs 20,000), drafts, cheque or through electronic mode.

The bonds will be issued in electronic form and credited to the Bond Ledger Account of the investor. A certificate of holding will be issued to the holder of the bonds as proof of subscription. Interest will be credited every half-year to the bank account of the investor. TDS, if applicable, will be deducted while paying the interest.

Applications for investment in the bond can be given in the branches of SBI, nationalized banks, IDBI Bank, Axis Bank, HDFC Bank and ICICI Bank, or any other entity authorized by the RBI from time to time. Nominations can be done by sole holders or sole surviving holders of these bonds.

Who is it suitable for?

The FRSB (2020) bond does not enjoy tax-breaks that small-savings schemes such as the NSC, PPF, Sukanya Samriddhi Yojana, and Senior Citizens Savings Scheme (SCSS) get in the old tax regime under Section 80C (up investments of Rs 1.5 lakh a year). The tax break can peg up the effective returns of these small savings schemes. So, if you opt for the old tax regime, first invest in the small savings schemes to get the tax break, and then consider investing in the FRSB (2020) bond.

If you opt for the new tax regime (with lower tax rates but without most tax breaks such as Section 80 C), the FRSB (2020) bond with its higher interest rate scores over most small savings schemes. So, the FRSB (2020) is a better choice straightaway. But the Sukanya Samriddhi Yojana (currently 7.6 per cent) and SCSS (currently 7.4 per cent) though offer better rates that the FRSB (2020) now. Besides, for senior citizens, interest received on deposits from banks and post offices is tax-exempt up to Rs 50,000 a year. So, for those in the new tax regime, it will be better to invest in the FRSB (2020) bond after exhausting the limit under Sukanya Samriddhi Yojana (Rs 1.5 lakh a year) and SCSS (Rs 15 lakh aggregate).

For those who seek to compound their wealth, the structure of the FRSB (2020) bond is not the most optimal, given that it is a non-cumulative instrument and will pay out interest half-yearly. In such cases, investors will need to re-invest the interest they receive, on their own in another FRSB bond or in other instruments to compound the money. This will entail re-investment risk though, that is, the rate of interest at the time of re-investment could be lower. If investors seeking cumulative returns want to lock in their rates at the time of investment, the FRSB will not be suitable as it is a floating rate product. Such investors should consider products such as bank fixed deposits or NSC in which the rate at the time of investment stays the same until maturity.

Also, for those who seek a fixed regular income, the FRSB bond may not be suitable since it is a floating rate product and the interest payout can vary every half-year depending on the rate reset. For those who seek fixed regular income, products such as SCSS and bank fixed deposits may be more suitable since the interest rate at the time of investment stays the same until maturity.

Key features

Issued by Government, 7-year tenure

Interest rate is 35 basis points above the NSC rate

Half-yearly interest payout

Half-yearly interest reset