Government Bonds India: Types, How to Invest, Interest Rates & Benefits

14 min read • Updated 15 September 2023
Written by Krishna Deshmukh
Government Bonds India

Bonds are debt instruments used by governments and other public/private sector entities to raise funds for their projects. In exchange, they pay guaranteed, predictable returns to the investors. Therefore, bonds are a win-win for both fundraising entities and investors. Depending on the issuing entities, bonds can be classified into government bonds, corporate bonds, public sector bonds, and municipal bonds. 

In this article, we will discuss about the government bonds in India. As the name suggests, government bonds are issued by the government. As the government backs them, these bonds are usually the most secure type of bonds to invest in. Read further to know their meaning, types, advantages, how to invest and their interest rates.

What are Government Bonds, and how do they work?

A government bond is issued by the government to borrow funds from the general public. When you buy a bond, you lend money to the government and, in return, you are paid periodic interest payments as per a pre-decided coupon rate. At maturity, you can redeem the principal amount, also called the “face value” of the bond. It is possible that the bond is issued at a discount to the face value. 

The Reserve Bank of India issues bonds on behalf of the government of India. These are tradeable and fungible government securities or G-Secs. In common parlance, government securities with a maturity of less than one year are called treasury bills, and those with longer maturity are called government bonds. 

They are practically risk-free and are called “gilts” or “gilt-edged securities.” For the purpose of this article, we will use government securities and government bonds interchangeably. 

Types of Government Bonds

There are different types of bonds issued by the government with different maturities, coupon rates, and other features:

1. Dated Government Securities

These securities have a fixed or floating interest rate paid semi-annually on their face value and can be redeemed at pre-specified maturity date. Generally, the tenure of these securities is 5 to 40 years. 

The nomenclature of dated government securities usually contains the coupon rate followed by the issuer followed by the maturity year. For example, “7.17% GS 2028” stands for a bond paying a coupon of 7.17%, issued by the Government of India and maturing in 2028. 

There are multiple types of Dated Government Securities:

Fixed-Rate Bonds

Government bonds with fixed rates have an interest rate set in advance and stay the same for the bond’s duration, offering predictable returns. Traditional investors favour these bonds because they are less risky. With the principle restored at maturity, investors will receive recurrent interest payments, typically semi-annually or yearly.

Floating Rate Bonds

Floating rate bonds feature interest rates tied to a benchmark rate, which means they fluctuate over the bond’s duration, providing a buffer against interest rate spikes. This means that the bond’s interest payments will vary over time, delivering possible benefits during higher interest rates. However, this unpredictability might bring an element of uncertainty into the income stream.

Inflation-Indexed Bonds

Inflation-indexed bonds are intended to safeguard investors from inflation by aligning the interest rate on these bonds with the inflation rate. The principal amount varies by the current inflation rate, which implies that both the interest payments and the redeemed principal at maturity are influenced by inflation to maintain the bond’s buying value.

Sovereign Gold Bonds

The Indian government issues sovereign gold bonds, which allow you to invest in gold without owning the physical metal. Investors get a periodic interest payment on the amount invested, with the final payoff dependent on the average gold price over the previous three days to maturity. This bond has the added benefit of capital appreciation if the market price of gold rises.

7.75% GOI Savings Bond

The 7.75% Government of India (GOI) savings bond has a set annual interest rate of 7.75% that is payable every six months. It has a 7-year maturity period and offers a comparatively high and stable interest rate when compared to many other fixed-income products. It is a safe investment because it is backed by the government, giving investors with security and dependability.

One can invest in these bonds by approaching their banking partner and expressing a desire to do so, thereby prompting the verification process through Aadhar and PAN cards.

Zero-Coupon Bonds

Zero-coupon bonds are issued at a discount to their face value and do not pay interest on a regular basis. Instead, interest accumulates and is compounded until maturity, when the investor receives the entire face value of the bond. This form of bond is advantageous to investors who want a lump sum at a later date and are willing to forego monthly interest payments.

2. Treasury Bills

These government securities come with three different maturity periods:

  • 91 days
  • 182 days
  • 364 days

These securities do not have any coupon payments. You can buy them at a discount to their face value. For example, a treasury bill with a face value of Rs. 100 is issued at a discounted price of, let’s say, Rs. 98.3. If you buy it, your gain at redemption would be Rs. (100 – 98.3) = Rs. 1.70.

The RBI auctions 91-day T-bills every Friday and 182-day and 364-day bills every second Wednesday.

3. Cash Management Bills

They are relatively newer instruments of investment and were launched in 2010 by the RBI for the first time in India. Their features are similar to those of T-bills, except that their maturity period is less than 91 days. They are not auctioned on a periodic basis by the RBI and are only issued to meet temporary mismatches in government cash flows.

4. State Development Loans

The bonds issued by state governments are referred to as “State Development Loans.” They are similar to Dated Government Securities as they have a fixed maturity date and pay interest at half-yearly intervals. The face value is redeemed at maturity. Their issues are also facilitated by the RBI through the Negotiated Dealing System. 

Also Read: Learn How to Buy Sovereign Gold Bond

How to Invest in Government Bonds in India? 

Buying Government Bonds through Direct Platform

Banks: Individuals can buy government bonds from banks and main dealers who are permitted to trade in government securities. They frequently facilitate purchases both at the initial offering and in the secondary market.

RBI Retail Direct Portal: The Reserve Bank of India has launched the RBI Retail Direct Portal, which allows ordinary investors to register an account and acquire government securities such as treasury bills and other bonds directly.

Investing in Government Bonds Through a Stock Broker

  1. Open a Demat and Trading Account: A Demat account is essential for trading and investing. If you don’t have one already, open both these accounts through your registered stockbroker.
  2. KYC Procedures: Make sure that you proceed with the Know Your Customer (KYC) compliance. This step involves the submission of crucial documents such as ID proof, address proof, and bank account particulars.
  3. Scouring the Market well: Research the different government bonds available before investing. Look at their interest rates, maturity periods, and other features to decide which suits your investment goals.
  4. Consult Your Broker: Contact your broker for advice and details on the bonds available for purchase. Brokers often provide insights and analyses to help you make an informed decision.
  5. Order Placement: Log in to your trading account and navigate to the government securities/bonds section. Select the bonds you wish to purchase and place an order specifying the number of units you want to buy.
  6. Settling your investment/Trades: The bonds will be credited to your demat account once your order is executed. You will receive periodic interest payments in your linked bank account, and upon maturity, the principal amount will be credited back to your bank account.

Through Mutual Funds

To invest in government bonds using mutual funds, first locate a gilt fund, which is a mutual fund that buys government bonds. Next, provide the appropriate documents with the mutual fund company to complete the KYC procedure. Then, either on the mutual fund’s website or through a financial advisor, you can invest a large sum or set up a systematic plan to invest a specified amount on a regular basis. Remember to monitor your investment and consult with a financial expert to better understand it. It’s a less complicated way to invest in government bonds without having to acquire them yourself.

Advantages of Investing in Government Bonds

Risk-Free Investment Instrument

These bonds are guaranteed by the government of India. The possibility of a default, therefore, is practically zero. So, if you are a risk-averse investor, these bonds are perfect for you.

Inflation Adjusted Returns

Inflation index bonds have provisions to adjust the principal and the interest amount as per the movement in the inflation index to ensure real returns. Similarly, capital indexed bonds have the principal amount adjusted as per an inflation index to prevent the capital from reducing in value due to inflation. That is, the face value at redemption is increased by a factor of the increase in inflation during the duration of the bond.

Highly Liquid

Government bonds are one of the most liquid investment instruments in the country, right next to cash, demand drafts, and cheques. You can even pledge them to get loans. Financial institutions can use these bonds to fulfil their SLR (Statutory Liquidity Ratio) requirements. They can be sold quickly in the secondary market with a settlement period of t+1 (settlement complete one day after the date of transaction).

Portfolio Diversification 

You can use government bonds to diversify the risk of your portfolio. By being risk-free, they reduce the overall risk exposure of your investment portfolio. They come with various maturity periods, from less than 91 days to 40 years. Therefore, you can ladder your investments using these.

Excellent Source of Regular Income

Government bonds that pay regular coupon payments can become a source of steady income for those who need one. People without a stable income source, such as freelancers, salespeople, etc., can invest in these bonds to ensure the stability of funds. These bonds are also an excellent tool for planning a retirement portfolio.

Disadvantages to Investing in Government Bonds

Low Returns

The returns that you get on government bonds are less than that on corporate bonds or equity instruments. Especially in the case of long-term bonds, when market interest rates go on increasing, the returns on government bonds eventually turn out to be very low. 

Interest Rate Risk

For government bonds with long-term maturity – 5 – 40 years. In this case, there is an interest rate risk. This is because, when the interest rates increase during the tenure of the bond, it becomes more beneficial to invest in newer bonds than the current ones. As a result, the bond prices drop to match the yield of the newer bonds. 

Risks Associated with Investing in Government Bonds in India

Market Risk: Developments day in and day out in the socio-economic landscape of your country can have a drastic impact on how the Government bonds are valued at a given point of time. Carefully invest in them to avoid such risks.

Reinvestment Risk: If you choose to reinvest your bonds during a period when interest rates have fallen, this can lead to a significant risk of losing out on potential returns than what you bought them for in the first place. 

Interest Rate Risk: Interest rate fluctuation is one of the most common risks associated with bonds. If you choose to sell your bond prematurely, you are likely to suffer a loss financially them when the interest rate falls.

Foreign Exchange Risk: Currency exchange values can drastically affect your gains if you are an investor who is investing from abroad. 

Inflation Risk: One unit of a currency will not be valued the same a year later thanks to inflation. Depending on the economic and financial status of your country, inflation plays a huge factor in affecting your gains from bonds. 

Credit Risk: Despite low risk for corporate bonds, defaulting from government agencies is not a far-fetched reality. In the event of a default, you might lose some or all of your money based on the severity of the default.

Risk of Liquidity: G-Secs are usually liquid, but given the low number of buyers, selling your bonds for some quick liquidity might prove to be a challenge.

Factors that Affect the Government Bond Prices

Interest Rates: Bond prices normally decline when interest rates rise, and vice versa. This is because old bonds’ fixed interest payments become less appealing when compared to new bonds issued with higher interest rates.

Fiscal Policies: Monetary and fiscal policies enacted by the government or central bank, such as changes in repo rates, can have an impact on bond prices.

Market Beliefs: The overall sentiment in the financial market, which is influenced by geopolitical events, economic forecasts, or global events, can alter demand and supply for government bonds, affecting their pricing.

Inflation: Higher inflation can erode the real value of the fixed interest payments provided by bonds, causing bond prices to fall.

Credit Rating: It is a given that G-Secs are low in risk, changes in the government’s credit rating can cause bond values to fluctuate.

Who Should Invest in Government Bonds?

Government bonds in India are one of the safest investment instruments. If you are totally risk averse, you should definitely consider investing in government securities. Another reason why you may consider investing in government bonds is to lower the overall risk exposure of your portfolio. 

Furthermore, if you are just a beginner, you can start by putting your savings in government bonds while you grasp the concepts of market-linked instruments such as stocks. 

Taxability on the Government Bonds in India

Investors holding government securities bonds in India should be aware of the following tax implications:

Interest Income: The interest earned on these bonds is taxed according to the individual’s applicable slab rate.

Short-Term Capital Gain: If the bonds are sold within a short holding period, any gains are taxed as per the individual’s applicable slab rate.

Long-Term Capital Gains: Depending on the specifics, long-term gains can be taxed at different rates:

Without Indexation: Gains are taxed at a rate of 10%.

With Indexation: The tax rate is 20%.

Unlisted Securities: If the securities are unlisted, the tax on the gains is 20%.

Key Takeaways

Government bonds are fixed-income investment instruments that come with a sovereign guarantee. Government bonds are practically risk-free. That being said, since the returns on government bonds are lower than equity and even other debt instruments like corporate bonds , you must consider your investment goals before investing in government securities. If you are aiming for significant passive income in the short term, investing in government bonds may not be a good idea. On the other hand, if you are a retired individual and are looking for a risk-free fixed income for the rest of your life, government bonds might be a good choice for you.

FAQs about Government bonds in India

What are bond yields?

Bond yield is the measure of the returns that you earn on a bond. They are calculated by dividing the coupon payments by the market price of the bond. When market interest rates increase, the bond yields of the newly issued bonds become more desirable. The bond prices of older bonds, therefore, fall in order to give the same bond yield as the new bonds. 

What are open market operations?

Open market operations are the activities of the RBI concerning buying and selling government bonds to manage the liquidity in the market. When it feels that the liquidity in the market is very high, it sells government bonds to reduce it. On the other hand, if it feels that the market is in need of some liquidity, it buys back bonds.

How and in what form can G-secs be held?

G-Secs can be held in both dematerialized form and physical form. The physical bonds are in the form of stock certificates. You need to open a Demat account with a securities broker in order to hold bonds in Demat form.

What are capital gain bonds?

Also called 54EC bonds, these are the bonds used to obtain a tax exemption on capital gains from the sale of immovable property. If you invest the profit earned from selling your property in these bonds within six months of the sale, you will be exempt from paying capital gains tax on this profit. Note that only an investment of up to Rs. 50 lakhs in capital gains bonds are exempt from taxation. Bonds issued by Rural Electrification Corporation (REC), National Highway Authority of India(NHAI), Power Finance Corporation Limited(PFC) or Indian Railway Finance Corporation Limited(IRFC) are capital gain bonds. 

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Krishna Deshmukh

Investment Principal
Krishna is an investment professional with a demonstrated history of working in Debt Capital Markets. He has completed his B.E. (Hons) in Computer Science Engineering from BITS Pilani and MBA (Finance) from JBIMS, Mumbai. He is currently working as Investments Principal at Wint Wealth. Previously he worked at Kotak Mahindra Bank at their DCM desk and Northern Arc Capital at their Structured Finance desk.

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